Ezra Friedman

Adverse selection as a barrier to entry in the banking industry

Banks offering credit to borrowers are faced with uncertainty about their creditworthiness. If banks obtain information about borrowers after lending to them, they are able to reject riskier borrowers when refinancing. Potential entrant banks will face an adverse-selection problem stemming from their inability to distinguish new borrowers from old borrowers who have been rejected by their previous bank. We analyze the effects of asymmetric information on the market structure of the banking industry. We characterize the equilibrium under Bertrand competition with two banks, and show than an equilibrium where a third bank enters does not exist (blockaded entry).

The Value of a Statistical Judgment: A New Approach to the Insurer's Duty to Settle

When liability insurance carries a limit that is smaller than the potential claim of a third party plaintiff, the insurer and the insured can have a conflict of interest as to settlement. The majority of jurisdictions in the United States impose upon insurers a duty to ignore liability limits when considering a settlement offer, and do not place limits on an insurers liability when the duty is violated. In this paper I take an incomplete contract approach and derive the optimal duty to settle. I propose limiting the insurers liability for an excess judgment to the Value of a Statistical Judgment (VSJ), which is derived from the amount a policy holder is willing to pay to avoid a risk of a large excess judgment. Setting damages for bad faith refusal to settle to the Value of Statistical Judgment causes the insurer to efficiently internalize the harm to the insured from an excess judgment. Although calculating the exact VSJ and corresponding duty to settle requires knowledge of the utility function of the insured, I show that courts can use a revealed preference approach to closely approximate the VSJ as a linear function of the liability limit and the vulnerable assets of the insured. The rule I propose applies excess liability which is a small multiple of the sum of the liability limit and the policy holders wealth. In addition to being nearly optimal rule from the ex-ante perspective for the insured, the proposed VSJ rule is attractive from a broader social welfare perspective; it discourages nuisance settlements, and directs more compensation towards victims with legitimate claims.

Competition Policy and Financial Distress

Traditional analyses of competition policy assume that firms operate in perfect credit markets. We argue that imperfections in credit markets should be taken into account, and show one channel by which accounting for financial conditions could alter the welfare eects of a merger. In line with empirical evidence, we posit that the presence of financial distress might diminish price competition by reducing firms’ willingness to undertake long-term investments in their customer base. Mergers that reduce the probability of financial distress can induce the merging firms to compete more fiercely for customers, thus partly osetting the traditional eects of an increase in market power. We use this