Delegated Cheap Talk: A Theory of Investment Banking (Job Market Paper)

Abstract

We study the role of investment banking as delegated cheap talk. In our model of initial public offering (IPO), two parties have conflicting interests: a seller wants to sell his firm, whereas a buyer wants to invest only in a good firm. All communication is cheap talk. We show that the seller can influence the buyer by contracting with an intermediary and delegating the communication. Any successful contract requires the intermediary to share the risk of loss with the buyer. A seller-optimal contract maximizes the intermediary’s bias in the seller’s favor while maintaining minimally sufficient alignment with the buyer’s incentives.