INVESTMENT AND GOVERNMENT INTERVENTION IN CREDIT MARKETS WHEN THERE IS ASYMMETRIC INFORMATION

This paper models private firm investment choices and government credit policy in an entrepreneurial firm financial market wherein firm owners have better information about the quality of their return distributions than do external financiers. The analysis shows that, despite the absence of an informational advantage, the government can often increase social welfare by offering subsidized debt contracts. However, the paper also finds that some common credit subsidy policies, including loan guarantees and government backing of targeted lending institutions, yield constrained inefficient outcomes in general. © 1991.