Firm Quality Dynamics and the Slippery Slope of Credit Intervention

Crises have cleansing effects—low-quality firms face greater financial shortfalls and invest less than high-quality firms—but public credit support dampens these effects by reducing financing cost differentials, distorting the firm quality distribution downward and reducing total productivity. This trade-off between preserving output capacity and distorting quality determines the optimal size of intervention. The distortionary effects are self-perpetuating: a downward bias in quality necessitates interventions of greater scale in future crises, implying further distortions—a “slippery slope.” The distortions are amplified by expectations: because low-quality firms expect underpriced government funding in future crises, their Tobin’s q is biased upward, leading them to overinvest even in normal times, while high-quality firms may underinvest. A low interest rate environment exacerbates the distortionary effects because the low yield on savings discourages firms from accumulating precautionary internal liquidity against crises.

Market Segmentation through Information

This paper asks what market outcomes an information designer — modeled as an internet platform that knows consumers’ preferences — can achieve by choosing what information to disclose to competing oligopolistic firms who then make personalized price offers. The model features n firms each producing a single differentiated product at zero cost, a continuum of consumers with unit demand and multidimensional valuations (one per product), and a designer who commits to a mapping from consumer types to joint distributions over messages sent to firms before they play a simultaneous pricing game. The designer’s objective spans the full range from maximizing producer surplus to maximizing consumer surplus.

Wenhao Li | Macro Paper Warehouse

Firm Quality Dynamics and the Slippery Slope of Credit Intervention

Market Segmentation through Information