Endogenous Information Collection : The Study of a Limited Liability Credit Market

We analyze a limited liability credit market where the borrowers need to borrow to implement their chosen projects with uncertain outcome. We allow borrowers to invest in resolution of the uncertainty in the project outcome before implementing the project. Our paper provides a complete characterization of the borrowers’ decision on investment in information for uncertainty resolution and project implementation. We show that the borrowers have more incentive to invest in information at higher rates of interest. If the cost of information goes down a borrower’s incentive to collect information increases. We also show that even a socially motivated lender may decide to charge a relatively high rate of interest and make positive profit under specific parameter values. Although a higher rate of interest induces the borrowers to choose relatively riskier projects