Information disclosure and the choice between arm’s-length and inside debt

Abstract

To study the consequences of information disclosure on economic exchange, we compare the differential information content of in-person (inside) and online (arm’s-length) loans. Confidential disclosures crucially shape the strategic dynamics of bank-borrower interaction and lead to trade-offs between the availability and pricing of credit. Inside debt carries higher interest but is more readily available whereas the opposite holds true for arm’s-length loans. Anticipating the bank’s use of inside information, firms strategically disclose information and switch lenders, which ultimately affects default. The observed availability-price trade-off corresponds to a novel mechanism for mitigating adverse selection relying on self-selection and disclosure.