Communication of soft information: Reputation and imperfect enforcement of reporting quality

Abstract

Entrepreneurs report unverifiable soft information to investors. The credibility of soft information depends on the entrepreneur's reputation concern. In equilibrium, high-talent entrepreneurs, who are better at developing profitable projects in the future and therefore have stronger reputation concerns, signal their talents by producing honest reports on current projects. We show how probabilistic third-party monitoring of reporting quality changes some firms’ reporting strategies, which again spill over to the financing costs of firms not directly affected by improved monitoring. In some cases, improved monitoring of reporting quality can reduce firms’ reputation concerns and result in less efficient communication of information.