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We now consider the situation in which z is the borrower’s private information and the implementation decision continues to be unobservable. Thus, the bank simultaneously faces both moral hazard and asymmetric information. To highlight the key difference relative to the setting in which there is only moral hazard, we refer to this setting simply asasymmetric information (AI), and take it to be understood that moral hazard is presentin addition to asymmetric information.

When the bank is uninformed aboutz, it must, in essence, provide incentives to overcome the borrower’s moral-hazard problem at the technology-adoption stage without knowing whether the borrower must decide between qh and p, or between p and ql. Formally, we require that the contract not be explicitly conditioned on z, but rather on the borrower’s report z_b only. The bank’s uncertainty about the nature of the borrower’s moral-hazard problem leads to tension between the optimal incentive provision in each state: the bank may have to forego providing incentives in one state of the world in order to efficiently provide them in the other state, or the bank must cede steep moral-hazard rents in order to be able to provide incentives in both states of the world. The optimal contract under

5 _{There is a slight subtlety in the implementation of the mean-preserving spread in terms of model}

parameters, since firm riskiness is defined in terms ofexpected outcomes. In particular, a change in expected outcomes does not uniquely identify a change in the underlying parameters. To most cleanly delineate the effects of increases in risk, we implement mean-preserving spreads such that expected wagesW andWfdo not change. In Appendix??, we show that wages are independent ofX, and that wages are never paid in every state of the world. Hence, we always have enough degrees of freedom to implement mean-preserving spreads in the desired manner.

asymmetric information will therefore fall into one of three classes: full-incentive contracts

(FI), in which the borrower chooses the efficient technology in every state of the world,

implementation contracts (I), in which the borrower chooses the new technology in every state of the world, and deterrence contracts (D), in which the borrower keeps the basic technology in every state of the world. We index a generic contract class by j, and refer to the contract that maximizes pledgeable income in each class as theoptimal contract within that class. The optimal contract under asymmetric information then is the optimal class-j

contract that delivers the highest pledgeable income across all contract classes.

We relegate a full analysis of the contracting problem to Appendix ??, and only present our key findings. In particular, Proposition 20 summarizes the properties of the optimal contract that allow us to derive empirical predictions for syndicate structure as a function of borrower characteristics.

Proposition 20 (Optimal Contract under Asymmetric Information). Let Wj denote the expected wage payments in the optimal class-j contract. Then we have:

1. The optimal deterrence contract consists of offering {κ1(l), w(l)}in every state of the

world. Hence, WD = 0 and pledgeable income is pX.

2. The optimal implementation contract consists of offering {κ1(h), w(h)} in every state

of the world. Hence, WI =Wf and pledgeable income is _eqX−γk₁−Wf.

3. Expected wages under the optimal full-incentive contract are higher than under the optimal implementation contract and the optimal symmetric-information contract:

WF I > WI and WF I > W. Pledgeable income is qX_b −γk1−WF I.

4. Pledgeable income in the optimal contract under asymmetric information is

b v= max n b qX−γk1−WF I,eqX−γk1−W , pXf o .

5. There exist thresholds Πl and Πh such that the optimal contract under asymmetric information is a full-incentive contract if and only if Πl_≥Πl _{and Π}h _≥Πh_.

Taking the difference betweenv and _bv reveals the value of information:

Corollary 10 (Value of Information). The value of information is

v−_bv= min n WF I−W , γ πh−k1 −W ,−(1−γ)πl+ (W −fW) o .

The following proposition shows that the value of information is weakly increasing in firm risk.

Proposition 21 (Value of Information and Risk). The value of information is weakly increasing in firm risk. In particular, the value of information is strictly increasing in firm risk ifΠl<Πl or Πh <Πh, and it is independent of firm risk if Πl ≥Πl, Πh ≥Πh, with at least one inequality being strict.

The proof is simple. If the optimal contract isnot a full-incentive contract, the proof follows directly from the proof of Proposition 19. In particular, as long as the optimal contract under asymmetric information induces an inefficient action in one state of the world, the costs of asymmetric information increase when the costs of choosing the wrong technology, defined by the payoff differences πh _{and π}l_{, increase. As highlighted in Remark 1, these}

costs increase precisely when riskiness increases. If the optimal contract is a full-incentive contract, the borrower chooses the efficient technology in every state of the world under both symmetric and asymmetric information. Hence, increased riskiness does not impact the value of information. Putting these pieces together, the value of information is weakly increasing in firm risk.