Delegated Monitoring in Public-Private Sector Credit Programs: Underinvestment, Overinvestment, and the Design of Subsidized Lending

Abstract

This paper studies public-private partnerships that delegate access-to-credit programs to private equity and venture-capital intermediaries. The public sector seeks to relax credit rationing and expand lending to socially valuable firms, while delegated monitors screen applicants, allocate subsidized loans, and bear agency costs. The paper develops a mechanism-design model showing that the same delegated intermediation structure can generate both Stiglitz-Weiss underinvestment and De Meza-Webb overinvestment distortions. When screening is imperfect, interest-rate sorting may exclude creditworthy target firms. When subsidies weaken monitoring and repayment incentives, high-risk firms may obtain excessive credit. The operative distortion is determined by monitoring curvature and subsidy intensity. The model further predicts that the feasible spread between loan contracts narrows as expected risk increases. A sequential extension incorporates credit scoring and Bayesian updating, showing that welfare loss from misclassification is minimized when monitoring resources are allocated according to the marginal effect of borrower characteristics on posterior risk classification. Because granular borrower-level data are unavailable, the empirical component provides descriptive state-year evidence from SBA SBIC reports (2018-2025) and a calibrated simulation illustrating that the model's comparative statics are empirically recoverable. The empirical analysis is presented as design validation rather than as a causal test.