Preserving "Debt Capacity" or "Equity Capacity": A Dynamic Theory of Security Design under Asymmetric Information

Roman Inderst and Vladimir Vladimirov

No 9923, CEPR Discussion Papers from Centre for Economic Policy Research

Abstract: In a dynamic model of optimal security design, we show when firms should preserve "equity capacity" through choosing high target leverage or "debt capacity" through choosing low target leverage. Thereby, firms reduce a problem of underinvestment or overinvestment when they must raise future financing under asymmetric information. Which problem arises depends on whether additional financing is raised at competitive terms or whether there is a lock-in with initial investors. Firms initial (or target) capital structure matters as it affects the "outside option" of both insiders and outside investors. Our theory also entails implications for start-up and venture capital financing.

Keywords: Asymmetric information; Capital structure; Dynamic security design; Venture capital financing (search for similar items in EconPapers)
JEL-codes: G32 (search for similar items in EconPapers)
Date: 2014-04
New Economics Papers: this item is included in nep-cta
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Working Paper: Preserving "Debt Capacity" or "Equity Capacity": A Dynamic Theory of Security Design under Asymmetric Information (2012)
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