Money, Financial Intermediation and Governance
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Money, Financial Intermediation and Governance

Dino Falaschetti and Michael J. Orlando

Dino Falaschetti and Michael Orlando unify the treatment of the many deeply related topics in money and banking in this wide-ranging book. By continually building on the assumption that economic actors are maximizers, they explain how monetary and financial services, as well as related governance mechanisms, influence economic performance. In this manner, Money, Financial Intermediation and Governance not only lets readers make sense of today’s monetary authorities and financial markets, it lets them see through superficial complexities to the fundamental influences that will shape those organizations for years to come.
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Chapter 13: Asymmetric Information

Dino Falaschetti and Michael J. Orlando


INTRODUCTION Consider, once more, our most simple model of the firm (see Part 1). In this model, firms maximize profits by employing production factors from an unbounded set. By positing that choice-sets are unconstrained, however, this model implicitly assumes that production factors costlessly move to their highest valued use, and thus abstracts from the potential for financial markets to influence economic performance. Just as we saw in Part II that goods and services do not costlessly move to their highest valued use (that is, bartering is costly), we’ll see in the present chapter that financial capital does not costlessly move to its highest valued use. Indeed, just as bartering deters even mutually beneficial trades by creating frictions in goods markets, asymmetric information discourages such trades by introducing frictions to financial markets. Likewise, just as money can enhance economic welfare by mitigating costs associated with bartering, financial intermediation and corporate governance can enhance welfare by mitigating costs associated with asymmetric information. A slightly richer model of the firm will help us develop this insight. Suppose that, instead of choosing from an unbounded set of factors, firms face a ‘cash constraint’ where limited internal resources preclude the hiring of factors that would maximize profits. In Figure 13.1, for example, the firm’s current assets might limit the employment of inputs to X , even though hiring inputs up to X* would increase profits. Even a cash-constrained firm can be a maximizer, however. Consequently, if it could expand production (and...

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