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Persuasion in relationship finance

Ehsan Azarmsa and Lin William Cong

Journal of Financial Economics, 2020, vol. 138, issue 3, 818-837

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.

Keywords: Bayesian persuasion; Experimentation; Hold-up; Information design; Relationship lending; Security design; Venture capital (search for similar items in EconPapers)
JEL-codes: D47 D82 D83 G14 G23 G28 (search for similar items in EconPapers)
Date: 2020
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DOI: 10.1016/j.jfineco.2020.06.018

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