Information Asymmetry at Debt Rollover and Startup Loans

This paper investigates the optimal design of information disclosure at debt rollover to maximize an entrepreneur’s ex ante borrowing capacity and social welfare. We develop a model where an entrepreneur secures a startup loan for project experimentation and must refinance for production. Borrowing capacity is limited by the pledgeability of project cash flows, which is eroded by three interacting forces: the entrepreneur’s moral hazard, premature liquidation risk following a liquidity shock, and rent dissipation arising from creditor competition. We show that a coarse “pass-or-fail” signal structure maximizes borrowing capacity. This binary structure is informative to balance incentive provision against liquidation risk, yet sufficiently coarse to mitigate rent dissipation. Furthermore, we demonstrate that the welfare-maximizing signal structure remains a pass-or-fail form, with an optimal threshold that tightens as the entrepreneur’s borrowing need increases.

This paper was accepted by Lin William Cong, finance.

Funding: H. Xu acknowledges support from the National Social Science Fund of China [Project Code: 23BJY251].

Supplemental Material: The online appendix is available at https://doi.org/10.1287/mnsc.2024.07999.