Ignorance Is Bliss: The Screening Effect of (Noisy) Information

22 Feb 2023  ·  Felix Zhiyu Feng, Wenyu Wang, Yufeng Wu, Gaoqing Zhang ·

This paper studies how the firm designs its internal information system when facing an adverse selection problem arising from unobservable managerial abilities. While more precise information allows the firm to make ex-post more efficient investment decisions, noisier information has an ex-ante screening effect that allows the firm to attract on-average better managers. The tradeoff between more effective screening of managers and more informed investment implies a non-monotonic relationship between firm value and information quality, and a marginal improvement of information quality does not necessarily lead to an overall improvement of firm value.

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