Managing Financial Expertise

We study credit markets in which lenders can invest in financial expertise to reduce the cost of acquiring information about underlying collateral. If the pledgeability of corporate income is low, information acquisition enhances liquidity, but lenders reduce expertise acquisition because of the hold-up problem. By contrast, if the pledgeability is high, information acquisition reduces liquidity so that lenders can extract rents from firms by investing in financial expertise and creating fear of illiquidity. Optimal policy involves subsidizing investment in financial expertise when the pledgeability is low and taxing investment in financial expertise when the pledgeability is high.