ANTI-COMPETITIVE FINANCIAL CONTRACTING: THE DESIGN OF FINANCIAL CLAIMS.



Then on average the investor makes negative profits with the second firm,
so if he did not receive any signal about the second firm, then he would not
want to fund it. The Coase problem arises only if the investor receives a
good signal about the second firm. Therefore an obvious way for the investor
to solve his Coase problem is to avoid learning the value of the signal. If
Firm
1 knows that the investor simply does not have the infra-structure or
expertise to interpret the signal, for example, then he knows he is safe from
investor expropriation. Thus the firm and the investor can benefit from the
investor failing to set up such means of monitoring, since it enables them to
write a more high-powered (debt-like) contract for the firm, inducing more
e
ffort. We interpret this variation of the model as one of commercial bank
lending. Venture capitalists (and universal banks) monitor the firms in which
they invest very closely, whereas in the UK and US, commercial banks do
notoriously little monitoring. This is a simple demonstration of the fact that
ill-informed investors will generally face fewer over-funding problems, and that
manipulation of the information available to the investor provides a second
means of solving the Coase problem. Of course, in this simple model lack of
monitoring is costless for the investor, whereas it will generally be associated
with adverse selection and moral hazard problems. Then investors must trade-
o
ff the costs of deliberately inducing such problems with their benefits (in the
form of reduced temptation to fund Firm 2). As we saw above, solving the
Coase problem through the design of financial claims is also costly in terms
of managerial e
ffort, so in general there will be a further trade-off to be made
between the two types of solution. In addition, there is also a well-known
feedback mechanism between the type of claim held and the incentive of the
investor to engage in monitoring (see e.g. Holmstrom and Tirole
1993). We
hope to investigate some of these issues in more detail in future work.

5.3 Imperfect Capital Markets and Industrial Concen-
tration

So far in this paper we have assumed that there is one investor who is the
unique source of funds for the industry. In this case, if the investor has ap-
propriate financial incentives to deny funding to Firm 2, the latter will not be
able to enter the industry and compete. To what extent is our analysis robust
to the introduction of competition in the credit market?

We address this issue at greater length elsewhere (Cestone-White 2000),
where we show that the main insights from the monopoly case continue to
hold as long as competition in the credit market is imperfect. The new feature
is that, when the first investor can be bypassed, some competitors may enter

17



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