INTRODUCTION Asymmetric information constrains the set of mutually beneﬁcial trades that an economy can support. Consider, for example, the ﬁrm’s proﬁtmaximization problem, and recall that our most simple model (see Part I) implicitly assumes that acquiring inputs is costless – that is, the act of transacting negligibly consumes resources. But when a ﬁrm’s internal resources cannot fund input choices, it must demand capital from ﬁnancial markets. This demand, in turn, must address constraints from asymmetric information. This asymmetry can emerge from those who might supply ﬁnancial resources having less information about a ﬁrm’s prospects than does the ﬁrm itself. In addition, potential suppliers likely have little information about how a ﬁrm would, after receiving a ﬁnancial market’s proceeds, actually employ those funds. Absent organizational features that check such asymmetries, suppliers will rationally forgo investing, even in technically valuable projects. In Chapter 14, we examined how intermediaries can economize on such costs and thus push economies toward the superior levels of performance that more simple treatments of the ﬁrm imply. We restricted our attention, however, to how proximate suppliers of ﬁnancial capital can mitigate information asymmetries. But the axiom of maximizing-behavior applies to all economic actors. Consequently, if suppliers of ﬁnancial capital want to mitigate information asymmetries, then so should demanders. They do, and recent corporate governance scandals (such as those associated with Adelphia, Enron, Tyco, WorldCom) highlight the important role that acting (or not acting) on this incentive plays in an economy’s performance. Absent productive actions from ﬁrms (that...
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