Financial Innovation and Delegation of Control

Norvald Instefjord

Economic Journal, 1998, vol. 108, issue 451, 1707-32

Abstract: The literature on security design has traditionally assumed that control of investment and production rests with the entrepreneur even after flotation. In this article, the author relaxes this assumption, which is both unnecessarily strict and unrealistic. The contribution is twofold. First, he shows that when control is delegated during flotation, financial innovation is a trade-off between agency costs (arising from principal agent relationships) and targeting costs (arising from the inability to split the cash flow). Second, the author shows that unlevered equity or the use of debt, which can be issued without defaulting in equilibrium, is an optimal means of financing.

Date: 1998
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