Ignorance Is Bliss: The Screening Effect of (Noisy) Information

Abstract

This paper studies the value of a firm's internal information when the firm faces an adverse selection problem arising from unobservable managerial abilities. While more precise information allows the firm to make ex post more efficient investment decisions, noisier information has an ex ante screening effect that allows the firm to attract onaverage better managers. The trade-off between more effective screening of managers and more informed investment implies a non-monotonic relationship between firm value and information quality. A marginal improvement in information quality does not necessarily lead to an overall improvement in firm value.

Keywords: JEL Classification: M41, D82, G34 internal information, screening, corporate governance, accounting noise

JEL Classification: M41, D82, G34