On the optimal investment finance of small businesses

Small businesses are frequently characterized by "information opacity" which results from several information asymmetries combined. Certain firm and institutional characteristics (e.g., their young age, small capitalization, and simplified accountancy requirements) make it hard for outside investors to verify their financial situation (net worth) and investment decisions at different stages of their realization. This work derives the (second-best) efficient investment and financial policies of small businesses when their opacity results in a possible adverse selection on entrepreneurs' initial net worth and in a double-moral hazard, on the firm investments and on the release of information on their realized earnings. Finally, these (second-best) efficient policies are compared with those documented in much of the empirical evidence on small companies.