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Debt- Versus Equity-Financing in Auction Designs

Charles Zheng

Staff General Research Papers Archive from Iowa State University, Department of Economics

Abstract: A social planner wishes to launch a project but the contenders capable of running the project are cash-constrained and may default. To signal their capabilities, the contenders may finance their bids through debt or equity, depending on the mechanism chosen by the social planner. When moral hazard is absent, it is established as theorems that the ex post efficient social choice function cannot be achieved by any mechanism using only debt financing and can be achieved by a mechanism using equity financing. When moral hazard is present, however, it is illustrated heuristically that equity share discourages effort and exacerbates default more than risky debt does.

Keywords: auction; finance; debt; equity; default; financial constraint; budget constraint (search for similar items in EconPapers)
JEL-codes: D44 D92 (search for similar items in EconPapers)
Date: 2010-05-18
New Economics Papers: this item is included in nep-cta, nep-mic and nep-ppm
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