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Credit and Efficiency in Centralized and Decentralized Economies

Credit and Efficiency in Centralized and Decentralized Economies Abstract We study a credit model where, because of adverse selection, unprofitable projects may nevertheless be financed. Indeed they may continue to be financed even when shown to be low-quality if sunk costs have already been incurred. We show that credit decentralization offers a way for creditors to commit not to refinance such projects, thereby discouraging entrepreneurs from undertaking them initially. Thus, decentralization provides financial discipline. Nevertheless, we argue that it puts too high a premium on short-term returns. The model seems pertinent to two issues: “soft budget constraint” problems in centralized economies, and differences between “Anglo-Saxon” and “German-Japanese” financing practices. This content is only available as a PDF. © 1995 The Review of Economic Studies Limited http://www.deepdyve.com/assets/images/DeepDyve-Logo-lg.png The Review of Economic Studies Oxford University Press

Credit and Efficiency in Centralized and Decentralized Economies

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References (6)

Publisher
Oxford University Press
Copyright
© 1995 The Review of Economic Studies Limited
ISSN
0034-6527
eISSN
1467-937X
DOI
10.2307/2298076
Publisher site
See Article on Publisher Site

Abstract

Abstract We study a credit model where, because of adverse selection, unprofitable projects may nevertheless be financed. Indeed they may continue to be financed even when shown to be low-quality if sunk costs have already been incurred. We show that credit decentralization offers a way for creditors to commit not to refinance such projects, thereby discouraging entrepreneurs from undertaking them initially. Thus, decentralization provides financial discipline. Nevertheless, we argue that it puts too high a premium on short-term returns. The model seems pertinent to two issues: “soft budget constraint” problems in centralized economies, and differences between “Anglo-Saxon” and “German-Japanese” financing practices. This content is only available as a PDF. © 1995 The Review of Economic Studies Limited

Journal

The Review of Economic StudiesOxford University Press

Published: Oct 1, 1995

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