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Two-sided asymmetric information and convertible securities in venture financing

Author

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  • Chang, Shih-Chung
  • Wang, Frank Yong

Abstract

This paper presents a new explanation for the prevalence of convertible securities in venture capital finance. Modeling two-sided asymmetric information between an entrepreneur and a venture capitalist, we demonstrate that convertible securities can result in the optimal contract. Our theoretical findings also provide some testable predictions. Specifically, the optimal conversion ratio rises when the information asymmetry problem worsens. We also reveal that the conversion ratio becomes smaller during economic booms since the adverse selection problem is less relevant.

Suggested Citation

  • Chang, Shih-Chung & Wang, Frank Yong, 2024. "Two-sided asymmetric information and convertible securities in venture financing," Economics Letters, Elsevier, vol. 237(C).
    • Handle: RePEc:eee:ecolet:v:237:y:2024:i:c:s0165176524001186
    DOI: 10.1016/j.econlet.2024.111635
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    More about this item

    Keywords

    Startup financing; Asymmetric information; Convertible security; Venture capital;
    All these keywords.

    JEL classification:

    • D84 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Expectations; Speculations
    • D86 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Economics of Contract Law
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • 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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