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Security Design with Investor Private Information

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    I study the security design problem of a firm when investors rather than managers have private information about the firm. I find that it is often optimal to issue information-sensitive securities like equity. The "folklore proposition of debt" from traditional signalling models only goes through if the firm can vary the face value of debt with investor demand. When the firm has several assets, debt backed by a pool of assets is optimal when the degree of competition among investors is low, while equity backed by individual assets can be optimal when competition is high.

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    Paper provided by Institute for Financial Research in its series SIFR Research Report Series with number 37.

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    Length: 54 pages
    Date of creation: 15 Oct 2005
    Date of revision:
    Handle: RePEc:hhs:sifrwp:0037
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    1. Wolfgang Pesendorfer & Jeroen M. Swinkels, 1997. "The Loser's Curse and Information Aggregation in Common Value Auctions," Econometrica, Econometric Society, vol. 65(6), pages 1247-1282, November.
    2. Franklin Allen & Andrew Winton, . "Corporate Financial Structure, Incentives and Optimal Contracting (Reprint 049)," Rodney L. White Center for Financial Research Working Papers 15-94, Wharton School Rodney L. White Center for Financial Research.
    3. Paul Milgrom & Robert J. Weber, 1981. "A Theory of Auctions and Competitive Bidding," Discussion Papers 447R, Northwestern University, Center for Mathematical Studies in Economics and Management Science.
    4. Cremer, Jacques & McLean, Richard P, 1985. "Optimal Selling Strategies under Uncertainty for a Discriminating Monopolist When Demands Are Interdependent," Econometrica, Econometric Society, vol. 53(2), pages 345-61, March.
    5. Subrahmanyam, Avanidhar, 1991. "A Theory of Trading in Stock Index Futures," Review of Financial Studies, Society for Financial Studies, vol. 4(1), pages 17-51.
    6. Habib, Michel A & Johnsen, D Bruce, 2000. "The Private Placement of Debt and Outside Equity as an Information Revelation Mechanism," Review of Financial Studies, Society for Financial Studies, vol. 13(4), pages 1017-55.
    7. Brennan, Michael J & Kraus, Alan, 1987. " Efficient Financing under Asymmetric Information," Journal of Finance, American Finance Association, vol. 42(5), pages 1225-43, December.
    8. Milgrom, Paul R, 1981. "Rational Expectations, Information Acquisition, and Competitive Bidding," Econometrica, Econometric Society, vol. 49(4), pages 921-43, June.
    9. Francesca Cornelli, 2001. "Bookbuilding and Strategic Allocation," Journal of Finance, American Finance Association, vol. 56(6), pages 2337-2369, December.
    10. Arnoud W A Boot & Anjan V Thakor, 1992. "Security Design," CEPR Financial Markets Paper 0020, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ..
    11. Gorton, Gary & Pennacchi, George, 1990. " Financial Intermediaries and Liquidity Creation," Journal of Finance, American Finance Association, vol. 45(1), pages 49-71, March.
    12. Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
    13. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
    14. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc.
    15. Franklin Allen, . "Stock Markets and Resource Allocation (Reprint 036)," Rodney L. White Center for Financial Research Working Papers 15-92, Wharton School Rodney L. White Center for Financial Research.
    16. Ilan Kremer, 2002. "Information Aggregation in Common Value Auctions," Econometrica, Econometric Society, vol. 70(4), pages 1675-1682, July.
    17. Harris, Milton & Raviv, Artur, 1991. " The Theory of Capital Structure," Journal of Finance, American Finance Association, vol. 46(1), pages 297-355, March.
    18. Nachman, David C & Noe, Thomas H, 1994. "Optimal Design of Securities under Asymmetric Information," Review of Financial Studies, Society for Financial Studies, vol. 7(1), pages 1-44.
    19. Inderst, Roman & Mueller, Holger M, 2003. "Credit Risk Analysis and Security Design," CEPR Discussion Papers 3686, C.E.P.R. Discussion Papers.
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