A Positive Theory of Information for Debt Contracting: Implications for Financial Reporting

Debt contracting creates demand for information from lenders to facilitate three distinct but related decisions: Lenders gather information prior to contract initiation for screening borrowers; later, once the contract is in force, lenders use information to assess changes in borrower default risk to determine the suitability of the initial contract terms; and finally, lenders collect information to ensure borrower compliance with information‐contingent contract terms. I examine what features of information are useful for these decisions, including whether the information is hard or soft; whether it is predictive or reflective; and whether the information includes just recurring components or whether it also admits non‐recurring information. Extensions of the base model are discussed to accommodate different institutional features of debt markets. I continue by considering how publicly reported financial information is potentially useful to lenders, and conclude by discussing avenues for future research.