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Separating equilibria, under-pricing and security design

Author

Listed:
  • Bernhardt, Dan

    (University of Illinois and University of Warwick)

  • Koufopoulos, Kostas

    (University of York)

  • Trigilia, Giulio

    (University of Rochester)

Abstract

Classical security design papers equate competitive capital markets to securities being fairly priced in expectation. We revisit Nachman and Noe (1994)'s adverse selection setting, modeling capital-market competition as free entry of investors, and allowing firms to propose prices of securities, as happens in private securities placements and bank lending. We show that separating equilibria exist in which high types issue under-priced debt, while low types issue more informationally-sensitive securities (e.g., equity). We also uncover pooling equilibria in which firms issue under-priced debt. These results provide foundations for the pecking-order theory of external finance, and positive profits for uninformed lenders.

Suggested Citation

  • Bernhardt, Dan & Koufopoulos, Kostas & Trigilia, Giulio, 2021. "Separating equilibria, under-pricing and security design," The Warwick Economics Research Paper Series (TWERPS) 1329, University of Warwick, Department of Economics.
    • Handle: RePEc:wrk:warwec:1329
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    References listed on IDEAS

    as
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    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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