Efficient audits by pooling independent projects: Separation vs. conglomeration

The article proposes a rationale for joint financing multiple independent projects based on the reduction of audit costs. The reduction holds not only when joint financing involves standard coinsurance gains, but, remarkably, also when it involves contagion losses -a succeeding project is dragged down by a failing one. This depends on a trade-off between the benefits from endogenous audit and the extra-cost coming from the unnecessary verification that a successful project may undergo when jointly financed. The article shows that debt is the optimal joint contractual arrangement and derives some testable predictions relating the emergence of joint financing to mean and variance of returns, bankruptcy costs, quality of accounting standards and sequencing of verification.