Persuasion in Relationship Finance
69 Pages Posted: 11 Oct 2017 Last revised: 2 Mar 2019
Date Written: February 20, 2019
Relationship finance as seen in bank lending and venture capital features incumbent financiers' observing interim information after initial investment but before continuation decision. We model the entrepreneurs' endogenous information production and subsequent issuance of securities to both the incumbent insider and competitive outsider investors as persuasion games with heterogeneous receivers and contingent transfers. Entrepreneurs' endogenous experimentation reduces insider investors' information monopoly, but holds up initial relationship investments. Insider financiers' own information production and interim competition from outsiders can mitigate the hold-up, and jointly explain the empirical non-monotone patterns linking competition and relational lending. Optimal relationship contracts restore first-best outcomes using convertible securities for insiders and residual claims for outsiders. Our findings do not rely on full commitment to information disclosure, and remain robust under restricted information design and continuum action space.
Keywords: Information Design, Security Design, Bayesian Persuasion, Relationship Lending, Moral Hazard, Hold-up, Experimentation, Venture Capital, Contracting
JEL Classification: D47, D82, D83, G14, G23, G28
Suggested Citation: Suggested Citation