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Optimal vs. Traditional Securities under Moral Hazard

Published online by Cambridge University Press:  06 April 2009

Michel A. Robe
Michel A. Robe
Affiliation:
School of Business, University of Miami, Coral Gables, FL 33124–6552.
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Abstract

This paper provides an explanation for the widespread use of traditional securities by well-established firms. Standard moral hazard models predict that equity, debt, and warrants are almost never optimal financing instruments. I show that issuing these securities is, nevertheless, nearly optimal: the issuer would gain very little by using non-traditional securities instead. Combined with equity, one debt issue (without multiple layers of seniority) and one warrant issue (without multiple exercise prices) suffice to achieve near optimality. The near optimality of traditional financing depends crucially on the issuer's ability to use warrants in addition to debt and equity.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 34 , Issue 2 , June 1999 , pp. 161 - 189
Copyright
Copyright © School of Business Administration, University of Washington 1999

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