Persuasion in Optimal Financing

49 Pages Posted: 4 Dec 2023 Last revised: 18 Feb 2024

See all articles by Shiming Fu

Shiming Fu

School of Finance, Shanghai University of Finance and Economics

Shuguang Zhu

Shanghai University of Finance and Economics - School of Economics

Date Written: November 27, 2023

Abstract

We examine the interplay between information disclosure and security design in a financing environment where auditing firm cash flows is costly. The optimal information structure involves disclosing a range of risk-return scenarios to induce a desired security combination consisting of a convertible debt and/or a performance-sensitive debt. Notably, converting debt into equity is shown to maximize financing probability. Calibrating interest rates based on performance effectively reduces external financing costs. We also find that the investor is persuaded to audit less, which not only mitigates the financing hold-up but also enhances the entrepreneur’s payoff. Intriguingly, we show that the value of the firm strictly increases with auditing costs, particularly when these costs are sufficiently high.

Keywords: Bayesian persuasion, costly state verification, convertible debt, performance-sensitive debt, welfare analysis

JEL Classification: D82, D83, G32

Suggested Citation

Fu, Shiming and Zhu, Shuguang, Persuasion in Optimal Financing (November 27, 2023). Available at SSRN: https://ssrn.com/abstract=4645558 or http://dx.doi.org/10.2139/ssrn.4645558

Shiming Fu (Contact Author)

School of Finance, Shanghai University of Finance and Economics ( email )

777 Guoding Road
Shanghai, AK Shanghai 200433
China

Shuguang Zhu

Shanghai University of Finance and Economics - School of Economics ( email )

777 Guoding Road
Shanghai, 200433
China

Do you have a job opening that you would like to promote on SSRN?

Paper statistics

Downloads
50
Abstract Views
154
PlumX Metrics