Put Your Money Where Your Mouth Is: A Model of Certification with Informed Finance

We consider how funding from informed investors such as banks certifies the quality of the recipient firms to investors uninformed of it. We show that informed finance leads to full separation of firms' quality types, with a larger quantity of it certifying a better quality. Moreover, the increase in the market value of the recipient firm is a convex, increasing function of the quantity of informed finance that it obtains. Lastly, firms with attribute X derive a greater value from the certification service of informed finance than those without it if the distribution of firms' quality conditional on X is second-order stochastically dominated by that conditional on its absence. The informed finance could be commercial bank loans or the purchase of a firm's equity preceding its IPO by renowned investment banks.