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Multiple-Project Financing with Informed Trading

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  • Salvatore Cantale

    (IMD International)

  • Dmitry Lukin

    (New Economic School)

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    Abstract

    The paper presents an adverse selection-based explanation of the fact that some entrepreneurs choose to finance multiple projects together by issuing a single security and other entrepreneurs decide to finance each project separately. We consider the financing problem of an entrepreneur who has access to two investment projects and needs to raise external financing to undertake these projects in the presence of asymmetric information. The entrepreneur has private information about the quality of the projects and can choose either to finance the projects together by issuing a single security, or to finance the projects separately by issuing two securities, each backed by the cash flows from the corresponding projects. We show that the choice of financing depends on the structure of information available to outside investors. If there are two types of informed traders and each type knows the true value of a different project, the entrepreneur will always choose to finance projects separately. However, if there is only one type of informed trader in the market and she has information about the true value of both projects, then the entrepreneur may, in some circumstances, resort to joint financing.

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    Bibliographic Info

    Article provided by Pepperdine University, Graziadio School of Business and Management in its journal Journal of Entrepreneurial Finance.

    Volume (Year): 16 (2012)
    Issue (Month): 1 (Spring)
    Pages: 1-28

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    Handle: RePEc:pep:journl:v:16:y:2012:i:1:p:1-28

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    Related research

    Keywords: Capital Budgeting; Adverse Selection; Outside Investment; Entrepreneur;

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    References

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    1. Kyle, Albert S, 1985. "Continuous Auctions and Insider Trading," Econometrica, Econometric Society, vol. 53(6), pages 1315-35, November.
    2. Bhagwan Chowdhry & Mark Grinblatt & David Levine, 2002. "Information Aggregation, Security Design and Currency Swaps," NBER Working Papers 8746, National Bureau of Economic Research, Inc.
    3. Vesa Kanniainen & Christian Keuschnigg, 2000. "The Optimal Portfolio of Start-Up Firms in Venture Capital Finance," CESifo Working Paper Series 381, CESifo Group Munich.
    4. Grossman, Sanford J & Stiglitz, Joseph E, 1980. "On the Impossibility of Informationally Efficient Markets," American Economic Review, American Economic Association, vol. 70(3), pages 393-408, June.
    5. Gorton, Gary B & Pennacchi, George G, 1993. "Security Baskets and Index-Linked Securities," The Journal of Business, University of Chicago Press, vol. 66(1), pages 1-27, January.
    6. Jose Marin & Rohit Rahi, 1996. "Information Revelation and Market Incompleteness," Archive Working Papers 024, Birkbeck, Department of Economics, Mathematics & Statistics.
    7. Habib, Michel A. & Johnsen, D. Bruce & Naik, Narayan Y., 1997. "Spinoffs and Information," Journal of Financial Intermediation, Elsevier, vol. 6(2), pages 153-176, April.
    8. Fulghieri, Paolo & Lukin, Dmitry, 2001. "Information production, dilution costs, and optimal security design," Journal of Financial Economics, Elsevier, vol. 61(1), pages 3-42, July.
    9. Peter M. DeMarzo, 2005. "The Pooling and Tranching of Securities: A Model of Informed Intermediation," Review of Financial Studies, Society for Financial Studies, vol. 18(1), pages 1-35.
    10. Roman Inderst & Holger M. Müller, 2003. "Internal versus External Financing: An Optimal Contracting Approach," Journal of Finance, American Finance Association, vol. 58(3), pages 1033-1062, 06.
    11. Bernile, Gennaro & Cumming, Douglas & Lyandres, Evgeny, 2007. "The size of venture capital and private equity fund portfolios," Journal of Corporate Finance, Elsevier, vol. 13(4), pages 564-590, September.
    12. Nanda, Vikram & Narayanan, M. P., 1999. "Disentangling Value: Financing Needs, Firm Scope, and Divestitures," Journal of Financial Intermediation, Elsevier, vol. 8(3), pages 174-204, July.
    13. Paolo Fulghieri, 2009. "Size and Focus of a Venture Capitalist's Portfolio," Review of Financial Studies, Society for Financial Studies, vol. 22(11), pages 4643-4680, November.
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