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Preserving "Debt Capacity" or "Equity Capacity": A Dynamic Theory of Security Design under Asymmetric Information

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  • Inderst, Roman
  • Vladimirov, Vladimir

Abstract

In a dynamic model of optimal security design, we show when firms should preserve "equity capacity" through choosing high target leverage or "debt capacity" through choosing low target leverage. Thereby, firms reduce a problem of underinvestment or overinvestment when they must raise future financing under asymmetric information. Which problem arises depends on whether additional financing is raised at competitive terms or whether there is a lock-in with initial investors. Firms’ initial (or target) capital structure matters as it affects the "outside option" of both insiders and outside investors. Our theory also entails implications for start-up and venture capital financing.

Suggested Citation

  • Inderst, Roman & Vladimirov, Vladimir, 2012. "Preserving "Debt Capacity" or "Equity Capacity": A Dynamic Theory of Security Design under Asymmetric Information," MPRA Paper 53840, University Library of Munich, Germany.
  • Handle: RePEc:pra:mprapa:53840
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    More about this item

    Keywords

    Dynamic Security Design; Capital Structure; Venture Capital Financing; Asymmetric Information;
    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

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