Financial Leverage, Information Quality, and Efficiency

In this paper, we examine how financial leverage and information quality interactively affect the equilibrium investment and effort decisions, therefore affect overall efficiency. We find that when the financial leverage is in an intermediate range, overall efficiency may decrease in information quality, because higher information quality discourages the entrepreneur from working hard when the prior project prospect is low. We also find that overall efficiency is very sensitive to financial leverage if information quality is poor; when information quality is higher, overall efficiency becomes less sensitive to leverage. In addition, given financial leverage, the optimal level of information quality to maximize overall efficiency in general "matches" the level of financial leverage