Firm Transparency and Outside Lending

Abstract

Existing lenders tend to have private information about borrowers, which implies that potential outside lenders face a winner’s curse. One might assume that outside lending increases with firm transparency, but this paper uses a benchmark model to show the opposite effect. Although firm transparency allows the outsider to win more good firms, the outsider also wins fewer bad firms. An analytical solution shows that total outside lending decreases with firm transparency. The prediction is tested using small business data and the results suggest that transparent firms are less likely to borrow from new lenders.