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Abstract:
We consider firm financing when the firm quality is private information of the manager and, given its inherent quality, the project viability depends on the manager exerting unobservable effort. We show that capital structure matters even though managerial contracts are optimally designed. Good firms would like to issue more debt to avoid selling underpricing equity. However, the interaction between managerial compensation and leverage does not allow them to do so. Because debt is senior to (the performance-related part of) managerial compensation, a high leverage prevents the implementation of the optimal managerial contract and so it destroys effort incentives. Therefore, we provide an explanation of why good firms appear to use debt conservatively and issue both debt and underpriced equity (even if the bankruptcy and agency costs of debt are zero). We also show that the optimal financial contract can be implemented by a combination of debt and equity.

Our results have also some interesting empirical implications: i) They are consistent with the well-documented negative relation between leverage and profitability. ii) Our model predicts that the higher the proportion of low-profitability (bad) firms, the higher the fraction of funds raised through equity. This prediction is consistent with the findings in Fama and French (2005).

Asymmetric Information, Capital Structure, Managerial Compensation

Abstract:
We consider project financing when the project quality is private information of the manager and, given its inherent quality, the project viability depends on the manager exerting unobservable effort. We show that capital structure matters even though managerial contracts are optimally designed. We also provide an explanation of why good firms issue both debt and underpriced equity (even if the bankruptcy and agency costs of debt are zero). Finally, we show that the optimal financial contract can be implemented by a combination of debt and equity. Our results have a number of testable implications.

Asymmetric Information, Capital Structure, Managerial Compensation

Abstract:
This paper presents a model of political competition, where voter decisions are affected by their ideological adherence to political parties. We derive a number of interesting results: First, we show that an equilibrium exists even though voting is fully deterministic. Second, corruption and inefficiencies arise as endemic phenomena of the political system. Third, if the distribution of ideology is asymmetric, then political contesters may follow different platforms in equilibrium. Fourth, political instability is desirable for selfish politicians, irrespectively of their risk aversion, because it weakens competition and becomes a natural base for rent-extractive policies. Finally, the higher the ideological adherence to a political party the more inefficient policies this party will follow. Some of these predictions are consistent with the results obtained by various empirical studies, while the rest, to the best of our knowledge, have not been tested yet.

corruption, political instability, voting behavior

Abstract:
This paper considers an economy with a public good where a decision must be made both about the level of the public good and the taxation imposed on each citizen (multidimensional policy space). In this context, we derive two interesting results: i) we show that a Nash equilibrium exists under deterministic voting, ii) we show that political competition is a necessary but not sufficient condition for the elimination of political rents (efficiency). In our political game a Nash equilibrium (under deterministic voting) exists because politicians commit to the level of the public good but not to the level of taxation. However, because of the lack of commitment to the taxation level, politicians are able to overtax citizens, provide an inefficiently low level of the public good and extract rents, even under political competition. Therefore, efficiency requires appropriate political institutions (maximum taxation constraint).

Lindahl allocation, political competition, political rents, voting games

Abstract:
In this paper we present a political economy approach in order to explain the degree of financial openness for an economy. In the model, entrepreneurs, who may have efficient or inefficient projects, vote for policies, which are proposed by selfish politicians. Two political frictions (ideological adherence and a super-majority requirement) impair political competition and give the power to contestants to propose inefficient policies regarding taxation and openness. We show that, in equilibrium, politicians exploit these frictions to receive corruption bribes and fund some inefficient projects. Furthermore, the model implies a non-monotonic relationship between financial openness and corruption and a positive relationship between financial openness and government size. The model predictions are consistent with various empirical findings.

corruption, financial openness, ideology, politicians

Abstract:
Competitive models of asymmetric information predict a positive relationship between coverage and risk. In contrast, most recent empirical studies find either negative or zero correlation. This paper, by introducing heterogeneity in risk perceptions into an asymmetric information competitive model, provides an explanation to this puzzle. If optimism discourages precautionary effort, there exist separating equilibria exhibiting the observed empirical patterns. It is also shown that zero correlation is consistent with information barriers to trade in insurance markets. The predictions of our model allow us to empirically distinguish it from standard asymmetric information models.

Asymmetric Information, Insurance, Risk Perceptions

Abstract:
In this paper we provide a political game where agents decide whether to become legislators or politicians. Legislators determine the political institutions constraining politicians' behavior and politicians compete for gaining the power to make decisions about the level of the public good. We derive a number of interesting results: i) Political competition is a necessary but not a sufficient condition for the elimination of political rents. ii) Agents utilize the separation of powers in order to endogenously select institutions which restrict the power of politicians. iii) In conjunction with political competition, these institutions implement the Lindahl allocation in the economy as a sub-game perfect Nash equilibrium of the political game. iv) As a consequence of the previous result, political rents are zero in equilibrium, in the sense that the politician in government does not extract part of the social surplus because of his power. To the best of our knowledge, this in the only citizen-candidate model with this equilibrium property.

Lindahl allocation, political competition, voting games