Koufopoulos, Kostas. (2009) Optimal securities under adverse selection and moral hazard. Journal of Mathematical Economics, Vol.45 (No.5-6). pp. 341-360. ISSN 0304-4068

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Abstract

We consider project financing under adverse selection and moral hazard and derive several interesting results. First, we provide an explanation of why good firms issue both debt and underpriced equity (even if the bankruptcy and agency costs of debt are zero). Second, we show that, in the presence of moral hazard, adverse selection may induce the conversion of negative into positive NPV projects leading to an improvement in social welfare. Third, we provide a rationale for the use of warrants. We also show that a debt–warrant combination can implement the optimal contract. Our results have a number of testable implications.

Item Type:	Journal Article
Subjects:	H Social Sciences > HG Finance
Divisions:	Faculty of Social Sciences > Politics and International Studies
Library of Congress Subject Headings (LCSH):	Adverse selection (Insurance), Moral hazard, Charities -- Investments, Risk (Insurance), Decision making -- Mathematical models
Journal or Publication Title:	Journal of Mathematical Economics
Publisher:	Elsevier BV
ISSN:	0304-4068
Date:	20 May 2009
Volume:	Vol.45
Number:	No.5-6
Page Range:	pp. 341-360
Identification Number:	10.1016/j.jmateco.2009.03.003
Status:	Peer Reviewed
Access rights to Published version:	Open Access
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URI:	http://wrap.warwick.ac.uk/id/eprint/1084

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