Optimal financing and disclosure

Research output: Contribution to journalArticlepeer-review

Abstract

I study an entrepreneur who finances a project with uncertain cash flows and who jointly chooses the disclosure and financing policies. In the Bayesian persuasion framework, I show that it is optimal to truthfully reveal whether the project’s cash flows are above a threshold. This class of threshold policies is optimal for any prior belief, monotone security, and increasing utility function of the entrepreneur. I characterize how the disclosure threshold depends on the underlying security, the prior, and the cost of investment. The financing choice of the entrepreneur is determined by a new trade-off between the likelihood of persuading investors and relinquishing cash flow rights. Absent further frictions, the optimal security is indeterminate. If there is adverse selection after the entrepreneur has disclosed information, the unique outcome is a pooling equilibrium in which the entrepreneur pledges the entire cash flow.

Original languageEnglish (US)
Pages (from-to)436-454
Number of pages19
JournalManagement Science
Volume67
Issue number1
DOIs
StatePublished - Jan 2021

Bibliographical note

Publisher Copyright:
Copyright: © 2020 INFORMS.

Keywords

  • Bayesian persuasion
  • Disclosure
  • Financing choice
  • Investment

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