TCU Neeley Research Highlight – Associate Professor of Accounting Xiaoyan Wen alongside an expert share research insights with industry and academic leaders.
August 30, 2023
TCU Neeley’s Xiaoyan Wen in collaboration with Lin Nan, studied how the quality of information and the amount of debt a business takes on interact when an entrepreneur seeks financing for a risky project where their effort affects the project's success. Their findings indicate that low financial leverage favors unclear information quality, as high precision can discourage effort. In contrast, high leverage suggests that clear information quality is beneficial, as it motivates effort despite reduced personal stakes. This analysis emphasizes how these factors jointly influence business efficiency and investment decisions. (Contemporary Accounting Research, 2023).
Abstract
We examine information quality and financial leverage when an entrepreneur needs financing to undertake a risky project and his effort input affects the project's outcome. We show that information quality and financial leverage interact to play active roles in both investment and effort decisions. Our analysis shows a positive association between leverage and optimal information quality—when leverage is low (high), low (high) information quality is optimal. This is because with low leverage, the entrepreneur is already motivated by his large share of the outcome to exert effort, and high information quality is not efficient as a precise bad signal discourages the entrepreneur's effort. In contrast, when leverage is high and thus the entrepreneur is less motivated by his residual cash flows, high information quality is optimal, because a precise good signal encourages the entrepreneur's effort. Our study highlights the joint effect of information quality and financial leverage on overall efficiency through firms' effort inputs as well as on defining investment efficiency.
