This paper investigates the optimal design of information disclosure at debt rollover to maximize an entrepreneur’s ex ante borrowing capacity and social welfare. We develop a model where an entrepreneur secures a startup loan for project experimentation and must refinance for production. Borrowing capacity is limited by the pledgeability of project cash flows, which is eroded by three interacting forces: the entrepreneur’s moral hazard, premature liquidation risk following a liquidity shock, and rent dissipation arising from creditor competition. We show that a coarse “pass-or-fail” signal structure maximizes borrowing capacity. This binary structure is informative to balance incentive provision against liquidation risk, yet sufficiently coarse to mitigate rent dissipation. Furthermore, we demonstrate that the welfare-maximizing signal structure remains a pass-or-fail form, with an optimal threshold that tightens as the entrepreneur’s borrowing need increases. This paper was accepted by Lin William Cong, finance. Funding: H. Xu acknowledges support from the National Social Science Fund of China Project Code: 23BJY251. Supplemental Material: The online appendix is available at https://doi.org/10.1287/mnsc.2024.07999 .
Huang et al. (Thu,) studied this question.