Two-sided asymmetric information and convertible securities in venture financing

Shih-Chung Chang and Frank Yong Wang

Economics Letters, 2024, vol. 237, issue C

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.

Keywords: Startup financing; Asymmetric information; Convertible security; Venture capital (search for similar items in EconPapers)
JEL-codes: D84 D86 G24 G32 (search for similar items in EconPapers)
Date: 2024
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Persistent link: https://EconPapers.repec.org/RePEc:eee:ecolet:v:237:y:2024:i:c:s0165176524001186

DOI: 10.1016/j.econlet.2024.111635

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