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Persuasion in relationship finance

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  • Azarmsa, Ehsan
  • Cong, Lin William

Abstract

After initial investments, relationship financiers routinely observe interim information about projects before continuing financing them. Meanwhile, entrepreneurs produce information endogenously and issue securities to incumbent insider and competitive outsider investors. In such persuasion games with differentially informed receivers and contingent transfers, entrepreneurs’ endogenous experimentation reduces insiders’ information monopoly but impedes relationship formation through an “information production hold-up.” Insiders’ information production and interim competition mitigate this hold-up and jointly explain empirical links between competition and relationship lending. Optimal contracts restore first-best outcomes using convertible securities for insiders and residuals for outsiders. Our findings are robust under various extensions and alternative specifications.

Suggested Citation

  • Azarmsa, Ehsan & Cong, Lin William, 2020. "Persuasion in relationship finance," Journal of Financial Economics, Elsevier, vol. 138(3), pages 818-837.
    • Handle: RePEc:eee:jfinec:v:138:y:2020:i:3:p:818-837
    DOI: 10.1016/j.jfineco.2020.06.018
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    Cited by:

    1. Oleg Muratov, 2023. "Entrepreneur–Investor Information Design," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 64(4), pages 1431-1467, November.
    2. Oleg Muratov, 2020. "Entrepreneur-Investor Information Design," Diskussionsschriften dp2014, Universitaet Bern, Departement Volkswirtschaft.

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    More about this item

    Keywords

    Bayesian persuasion; Experimentation; Hold-up; Information design; Relationship lending; Security design; Venture capital;
    All these keywords.

    JEL classification:

    • D47 - Microeconomics - - Market Structure, Pricing, and Design - - - Market Design
    • D82 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Asymmetric and Private Information; Mechanism Design
    • D83 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Search; Learning; Information and Knowledge; Communication; Belief; Unawareness
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G23 - Financial Economics - - Financial Institutions and Services - - - Non-bank Financial Institutions; Financial Instruments; Institutional Investors
    • G28 - Financial Economics - - Financial Institutions and Services - - - Government Policy and Regulation

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