This paper develops a dynamic model of capital structure and investment. Ina world with low and high ability managers, the former mask as the latter, but todo so have to overstate both earnings and investment. Debt is a mechanism thateventually separates investors’ abilities, at the cost of intervening unlucky highproductivity managers. Immediate separation is counterproductive, as it generatescosts and no expected payoff. The security design that asymptotically implementsoptimal investment includes the use of excess non-operating cash, of proportionalcash flow compensation, and of ”golden parachutes”. Relative to a first best case,high ability managers will underinvest. Low ability managers will generally overin-vest, except when their firm is close to bankruptcy, in which case they will loot thecompany by underinvesting and overstating their earnings.