'Royal College of Obstetricians & Gynaecologists (RCOG)'
Abstract
We study an economy with financial frictions in which a regulator designs a test that reveals outside information about a firm’s quality to investors. The firm can also disclose
verifiable inside information about its quality. We show that the regulator optimally
aims for “public speech and private silence”, which is achieved with tests that give
insiders an incentive to stay quiet. We fully characterize optimal tests by developing
tools for Bayesian persuasion with incentive constraints, and use these results to derive
novel guidance for the design of bank stress tests, as well as benchmarks for socially
optimal corporate credit rating