Screening and Financial Contracting in the Face of Outside Competition

Abstract

I consider an investor who can acquire a costly signal about an entrepreneur's project. The investor's problem is that uninformed investors can compete to provide funding and his contract offer conveys information to the entrepreneur about project payoffs, affecting the attractiveness of the uninformed funding alternatives. I determine how project primitives affect the investor's signal quality choice and contracting terms. Equilibrium expected payoffs are unique. Further, equilibrium strategies solve simple optimal contracting problems. Informed investors can use equity, while uninformed investors compete with debt. Introducing commitment by the informed investor alters the structure of the game, but not equilibrium payoffs.