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To authenticate to the full-text of this article, please visit this link: http://dx.doi.org/10.3982/ECTA7261 Byline: Bruno Biais (*), Thomas Mariotti (**), Jean-Charles Rochet (***), Stephane Villeneuve ([dagger]) Keywords: Principal-agent model; limited liability; continuous time; Poisson risk; downsizing; investment; firm size dynamics Abstract: We study a continuous-time principal-agent model in which a risk-neutral agent with limited liability must exert unobservable effort to reduce the likelihood of large but relatively infrequent losses. Firm size can be decreased at no cost or increased subject to adjustment costs. In the optimal contract, investment takes place only if a long enough period of time elapses with no losses occurring. Then, if good performance continues, the agent is paid. As soon as a loss occurs, payments to the agent are suspended, and so is investment if further losses occur. Accumulated bad performance leads to downsizing. We derive explicit formulae for the dynamics of firm size and its asymptotic growth rate, and we provide conditions under which firm size eventually goes to zero or grows without bounds. Author Affiliation: (*)Toulouse School of Economics (CNRS, GREMAQ, IDEI), Universite Toulouse 1, 21 Allee de Brienne, 31000 Toulouse, France;biais@cict.fr (**)Toulouse School of Economics (CNRS, GREMAQ, IDEI), Universite Toulouse 1, 21 Allee de Brienne, 31000 Toulouse, France;mariotti@cict.fr (***)Toulouse School of Economics (GREMAQ, IDEI), Universite Toulouse 1, 21 Allee de Brienne, 31000 Toulouse, France;rochet@cict.fr ([dagger])Toulouse School of Economics (CRM, IDEI), Universite Toulouse 1, 21 Allee de Brienne, 31000 Toulouse, France;stephane.villeneuve@univ-tlse1.fr Article History: Manuscript received July, 2007; final revision received September, 2009.

We study how early-stage new ideas are turned into successful businesses. Even promising ideas can be unprofitable if they fail on one dimension, such as technical feasibility, correspondence to market [...]

We study how securities and issuance mechanisms can be designed to mitigate the adverse impact of market imperfections on liquidity. In our model, asset owners seek to obtain liquidity by selling claims contingent on privately observed future cash-flows. Liquidity suppliers can be competitive or strategic. In the optimal trading mechanism associated with an arbitrary given security, issuers with low cash-flows sell their entire holdings of the security, while issuers with high cash-flows are typically excluded from trade. By designing the security optimally, issuers can avoid exclusion altogether. We show that the optimal security is debt. Because of its low informational sensitivity, debt mitigates the adverse selection problem. Furthermore, by pooling all issuers with high cash-flows, debt also reduces the ability of a monopolistic liquidity supplier to exclude them from trade in order to better extract rents from issuers with lower cash-flows.

We measure the degree of overconfidence in judgement (in the form of miscalibration, i.e. the tendency to overestimate the precision of one's information) and self-monitoring (a form of attentiveness to social cues) of 245 participants and also observe their behaviour in an experimental financial market under asymmetric information. Miscalibrated traders, underestimating the conditional uncertainty about the asset value, are expected to be especially vulnerable to the winner's curse. High self-monitors are expected to behave strategically and achieve superior results. Our empirical results show that miscalibration reduces and self-monitoring enhances trading performance. The effect of the psychological variables is strong for men but non-existent for women.

We analyze politically motivated privatization in a bipartisan environment. When median-class voters a priori favor redistributive policies, a strategic privatization program allocating them enough shares can induce a voting shift away from left-wing parties whose policy would reduce the value of shareholdings. To induce median-class voters to buy enough shares to shift political preferences, strategic rationing and underpricing is often necessary. In the extreme, this may lead to free share distribution and voucher privatization. Shifting voting preferences becomes impossible when strong ex ante political constraints require large upfront transfers to insiders or when social inequality is extreme. (JEL D72, L33, P16, P35)

We analyse the optimal Initial Public Offering (IPO) mechanism in a multidimensional adverse selection setting where institutional investors have private information about the market valuation of the shares, the intermediary has private information about the demand, and the institutional investors and intermediary collude. Theorem I states that uniform pricing is optimal (all agents pay the same price) and characterizes the IPO price in terms of conditional expectations. Theorem 2 states that the optimal mechanism can be implemented by a non-linear price schedule decreasing in the quantity allocated to retail investors. This is similar to IPO procedures used in the U.K. and France. Relying on French IPO data we perform a GMM structural estimation and test of the model. The price schedule is estimated and the conditions characterizing the optimal mechanism are not rejected.

Consider strategic risk-neutral traders competing in schedules to supply liquidity to a risk-averse agent who is privately informed about the value of the asset and his hedging needs. Imperfect competition in this common value environment is analyzed as a multiprincipal game in which liquidity suppliers offer trading mechanisms in a decentralized way. Each liquidity supplier behaves as a monopolist facing a residual demand curve resulting from the maximizing behavior of the informed agent and the trading mechanisms offered by his competitors. There exists a unique equilibrium in convex schedules. It is symmetric and differentiable and exhibits typical features of market-power: Equilibrium trading volume is lower than ex ante efficiency would require. Liquidity suppliers charge positive mark-ups and make positive expected profits, but these profits decrease with the number of competitors. In the limit, as this number goes to infinity, ask (resp. bid) prices converge towards the upper (resp. lower) tail expectations obtained in Glosten (1994) and expected profits are zero. Keywords: Multi-principals, mechanism design, competing market-makers, financial markets microstructure.

Data for manufacturing companies in Cote d'Ivoire is used as the basis of research into the roles of the formal and informal credit markets in developing nations. It is concluded that the natural functioning of the market is unlikely to produce optimal investment, growth and economic development.