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Security design with status concerns

Author

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  • Basak, Suleyman
  • Makarov, Dmitry
  • Shapiro, Alex
  • Subrahmanyam, Marti

Abstract

This paper provides a status-based explanation for convertible securities. An entrepreneur with status concerns inducing risk-taking decides how to finance the firm and how to dynamically manage it. Solving analytically for the optimal security, we find that it is substantially similar to a convertible security. Our model can explain why convertible securities are mainly issued by start-ups and small firms, as we show that their salient characteristics, higher volatility and dynamic flexibility, accentuate incentives to issue convertible securities. We also provide analytical results relevant to quantifying how status concerns affect credit risk, an established factor behind security choice.

Suggested Citation

  • Basak, Suleyman & Makarov, Dmitry & Shapiro, Alex & Subrahmanyam, Marti, 2020. "Security design with status concerns," Journal of Economic Dynamics and Control, Elsevier, vol. 118(C).
    • Handle: RePEc:eee:dyncon:v:118:y:2020:i:c:s0165188920301445
    DOI: 10.1016/j.jedc.2020.103976
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    Cited by:

    1. Makarov, Dmitry, 2021. "Optimal portfolio under ambiguous ambiguity," Finance Research Letters, Elsevier, vol. 43(C).
    2. Xu, Jing, 2022. "Competition and equilibrium effort choice," Journal of Economic Dynamics and Control, Elsevier, vol. 137(C).
    3. Joshua Shemesh, 2017. "CEO Social Status and Risk-Taking," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 7(02), pages 1-35, June.

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    More about this item

    Keywords

    Security design; Status concerns; Convertible securities; Financing; Hybrid securities;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law

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