CREDIT MARKET IMPERFECTIONS AND THE SEPARATION OF OWNERSHIP FROM CONTROL

This paper offers a model of credit markets with adverse selection and moral hazard. The equilibrium is highly inefficient, and the underlyi ng reason is the zero-profit condition imposed by competing financial intermediaries which gives very high powered incentives to entrepreneu rs. The paper demonstrates that when entrepreneurs can hire a manager to run their projects, the inefficiencies are prevented. This is becau se the manager is not the residual claimant of the returns, and hence has low powered incentives. Therefore, the divergence of interests bet ween owners and managers may have beneficial effects as well as the of ten emphasized costs. (C) 1998 Academic Press.