Persuasion in Relationship Finance

49 Pages Posted: 15 Aug 2017 Last revised: 1 Nov 2019

See all articles by Ehsan Azarmsa

Ehsan Azarmsa

University of Illinois Chicago, College of Business Administration

Lin William Cong

Cornell University - Samuel Curtis Johnson Graduate School of Management; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: October 31, 2019

Abstract

After initial investments, relationship financiers typically 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 deferentially 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

JEL Classification: D47, D82, D83, G14, G23, G28

Suggested Citation

Azarmsa, Ehsan and Cong, Lin, Persuasion in Relationship Finance (October 31, 2019). Available at SSRN: https://ssrn.com/abstract=3016102 or http://dx.doi.org/10.2139/ssrn.3016102

Ehsan Azarmsa

University of Illinois Chicago, College of Business Administration ( email )

University Hall, 601 S Morgan St
Chicago, IL 60654
United States
3122567183 (Phone)

Lin Cong (Contact Author)

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States

HOME PAGE: http://www.linwilliamcong.com/

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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