Money, reputation and inventories under credit market imperfections
This thesis analyses the way in which credit market imperfections affect the behaviour of economic agents, and examines how a variety of tangible or intangible assets such as fiat money, reputation and inventories, facilitate bilateral exchange and influence investment decisions of firms under such circumstances. The first chapter of the thesis deals with the role of fiat money as a medium of exchange in a model in which agents hold consumable goods or nonconsumable cash. The physical environment of pairwise random matching for bilateral trade, however, prevents them from issuing debt certificates. Unlike fiat money, consumables have uncertain quality characteristics, and agents can only detect the quality of a subset of goods. As a consequence, barter is plagued by asymmetric information, whereas monetary exchange involving generally recognisable legal tender is not. This suggests that it is because of, rather than despite, its intrinsic uselessness that, as a medium of exchange, fiat money is superior to goods or assets subject to some form of quality uncertainty. The second chapter examines the effects of reputation and internal finance on a firm's investment incentives. An entrepreneur with unknown productivity finances risky production with a combination of internal finance and funds from external investors who, just like himself, are able to learn about his true productivity over time, a process that influences their willingness to lend. However, investment decisions taken by the entrepreneur, are not observable to outsiders. This information problem leads not only to underinvestment but also to premature liquidation. It is shown that the acquisition of reputation and internal funds may counteract such undesirable outcomes. On the other hand, it becomes clear that when assets are low, incentives to invest are disrupted because of a high probability of liquidation in the near future. Young firms appear to be particularly susceptible to effects of this type. Finally, the third chapter studies inventory investment and internal-finance decisions of a financially constrained firm facing an uncertain demand process. The model gives an explanation for the stylised fact that production is more volatile than sales. Assuming that firms have limited access to capital markets they are forced to rely on internal finance. However, following a series of unfavourable sales realisations such funds possibly are so low that firms find themselves unable to re-establish the old inventory level in subsequent periods. Conversely, after a series of high sales the firm has a substantive amount of money to finance output quantities that may be in excess of sales.