Accounting Information and Risk Shifting with Asymmetrically Informed Creditors

Abstract

This paper explores the effects of public information (e.g., accounting earnings) in a competitive lending setting where the borrower can engage in risk shifting. If a privately informed inside creditor bids against outsider creditors, public information levels the playing field with nontrivial effects on bidding and risk-shifting. A perfect public signal would yield the least efficient outcome: introducing some measurement noise alleviates risk shifting by subjecting the outsider to the winner's curse. However, for pessimistic priors about the borrower, greater precision can alleviate risk shifting, locally. We derive conditions under which greater signal precision lowers the probability of creditor turnover and discuss implications for financial reporting regulations along the business cycle.