Credit and efficiency in centralized and decentralized economies
The authors study a credit model where, because of adverse selection, unprofitable projects may nevertheless be financed. Indeed, they may have to be financed even when shown to be low-quality if sunk costs have already been incurred. The authors 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, the authors 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. Copyright 1995 by The Review of Economic Studies Limited.
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