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Optimal security design under asymmetric information and profit manipulation
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Koufopoulos, Kostas, Kozhan, Roman and Trigilia, Giulio (2019) Optimal security design under asymmetric information and profit manipulation. Review of Corporate Finance Studies, 8 (1). pp. 146-173. doi:10.1093/rcfs/cfy008 ISSN 2046-9128.
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Official URL: https://doi.org/10.1093/rcfs/cfy008
Abstract
We consider a model of external financing in which entrepreneurs are privately informed about the quality of their projects and seek funds from competitive financiers. The literature restricts attention to monotonic, or “manipulation proof,” securities and finds that straight debt is the uniquely optimal contract. Monotonicity is commonly justified by the argument that it would endogenously arise if the entrepreneur can window dress the realized earnings before contract maturity. We explicitly characterize the optimal contracts when entrepreneurs engage in window dressing and/or output diversion and derive necessary and sufficient conditions for straight debt to be optimal. Contrary to conventional wisdom, debt is often suboptimal, and it is never uniquely optimal. Optimal contracts are nonmonotonic and induce profit manipulation in equilibrium. They can be implemented as performance-sensitive debt.
Item Type: | Journal Article | ||||||||
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Subjects: | H Social Sciences > HB Economic Theory H Social Sciences > HG Finance |
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Divisions: | Faculty of Social Sciences > Warwick Business School | ||||||||
Library of Congress Subject Headings (LCSH): | Securities, Entrepreneurship, Profit, Debt | ||||||||
Journal or Publication Title: | Review of Corporate Finance Studies | ||||||||
Publisher: | Oxford University Press | ||||||||
ISSN: | 2046-9128 | ||||||||
Official Date: | 1 March 2019 | ||||||||
Dates: |
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Volume: | 8 | ||||||||
Number: | 1 | ||||||||
Page Range: | pp. 146-173 | ||||||||
DOI: | 10.1093/rcfs/cfy008 | ||||||||
Status: | Peer Reviewed | ||||||||
Publication Status: | Published | ||||||||
Reuse Statement (publisher, data, author rights): | This is a pre-copyedited, author-produced version of an article accepted for publication in Review of Corporate Finance Studies following peer review. The version of record Kostas Koufopoulos, Roman Kozhan, Giulio Trigilia; Optimal Security Design under Asymmetric Information and Profit Manipulation, The Review of Corporate Finance Studies, , cfy008, is available online at: https://doi.org/10.1093/rcfs/cfy008 | ||||||||
Access rights to Published version: | Restricted or Subscription Access | ||||||||
Date of first compliant deposit: | 24 September 2018 | ||||||||
Date of first compliant Open Access: | 17 January 2019 | ||||||||
Related URLs: | |||||||||
Open Access Version: |
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