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Financing and Taxing New Firms under Asymmetric Information


  • Robin Boadway
  • Michael Keen


This paper uses a sequence of models to study the efficiency of credit-market equilibria, and the scope for welfare-improving policy interventions, when financial intermediaries cannot observe the riskiness or returns of potential investment projects by new firms. It is first shown that when only loan financing is available there is a systematic tendency towards overinvestment in high-return, high-risk projects and underinvestment in low-return, low-risk projectsrelative to the social optimum [this encompasses the well-known results of Stiglitz and Weiss (1981) and de Meza and Webb (1987) as special cases]. The ambiguity is mitigated, however, if firms have access to equity financing: there is then (under reasonable conditions) unambiguously overinvestment. Policy implications are developed, and the results extended to allow for screening and signaling equilibria.

Suggested Citation

  • Robin Boadway & Michael Keen, 2006. "Financing and Taxing New Firms under Asymmetric Information," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 62(4), pages 471-502, December.
  • Handle: RePEc:mhr:finarc:urn:sici:0015-2218(200612)62:4_471:fatnfu_2.0.tx_2-g
    DOI: 10.1628/001522106X172661

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    References listed on IDEAS

    1. Boadway, Robin & Sato, Motohiro, 1999. " Information Acquisition and Government Intervention in Credit Markets," Journal of Public Economic Theory, Association for Public Economic Theory, vol. 1(3), pages 283-308.
    2. Bernheim, B. Douglas, 2002. "Taxation and saving," Handbook of Public Economics,in: A. J. Auerbach & M. Feldstein (ed.), Handbook of Public Economics, edition 1, volume 3, chapter 18, pages 1173-1249 Elsevier.
    3. Chamley, Christophe, 1986. "Optimal Taxation of Capital Income in General Equilibrium with Infinite Lives," Econometrica, Econometric Society, vol. 54(3), pages 607-622, May.
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    Cited by:

    1. Vesa Kanniainen & Panu Poutvaara, 2007. "Imperfect Transmission of Tacit Knowledge and other Barriers to Entrepreneurship," CESifo Working Paper Series 2053, CESifo Group Munich.
    2. Tuomas Takalo, 2012. "Rationales and Instruments for Public Innovation Policies," Journal of Reviews on Global Economics, Lifescience Global, vol. 1, pages 157-167.
    3. Robin Boadway & Motohiro Sato, 2011. "Entrepreneurship and asymmetric information in input markets," International Tax and Public Finance, Springer;International Institute of Public Finance, vol. 18(2), pages 166-192, April.
    4. Luis H. B. Braido & Carlos E. da Costa & Bev Dahlby, 2011. "Adverse Selection and Risk Aversion in Capital Markets," FinanzArchiv: Public Finance Analysis, Mohr Siebeck, Tübingen, vol. 67(4), pages 303-326, December.
    5. Wolfgang Buchholz & Kai A. Konrad, 2014. "Taxes on risky returns — an update," Working Papers tax-mpg-rps-2014-10, Max Planck Institute for Tax Law and Public Finance.
    6. Keuschnigg, Christian & Ribi, Evelyn, 2010. "Profit Taxation, Innovation and the Financing of Heterogeneous Firms," CEPR Discussion Papers 7626, C.E.P.R. Discussion Papers.
    7. Tuomas Takalo & Tanja Tanayama, 2010. "Adverse selection and financing of innovation: is there a need for R&D subsidies?," The Journal of Technology Transfer, Springer, vol. 35(1), pages 16-41, February.
    8. Francesco Cohen & Alessandro Fedele & Paolo M. Panteghini, 2016. "Corporate taxation and financial strategies under asymmetric information," Economia Politica: Journal of Analytical and Institutional Economics, Springer;Fondazione Edison, vol. 33(1), pages 9-34, April.
    9. Kleer, Robin, 2010. "Government R&D subsidies as a signal for private investors," Research Policy, Elsevier, vol. 39(10), pages 1361-1374, December.
    10. Vesa Kanniainen & Mikko Leppämäki, 2009. "Union power, entrepreneurial risk, and entrepreneurship," Small Business Economics, Springer, vol. 33(3), pages 293-302, October.
    11. Tuomas Takalo & Otto Toivanen, 2012. "Entrepreneurship, Financiership, and Selection," Scandinavian Journal of Economics, Wiley Blackwell, vol. 114(2), pages 601-628, June.

    More about this item


    credit markets; asymmetric information;

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G18 - Financial Economics - - General Financial Markets - - - Government Policy and Regulation


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