Persuasion in Relationship Finance
49 Pages Posted: 11 Oct 2017 Last revised: 1 Nov 2019
Date Written: October 2019
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 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
JEL Classification: D47, D82, D83, G14, G23, G28
Suggested Citation: Suggested Citation