Hostname: page-component-848d4c4894-r5zm4 Total loading time: 0 Render date: 2024-06-25T12:00:52.920Z Has data issue: false hasContentIssue false
  • English
  • Français

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.
Get access Rights & Permissions [Opens in a new window]

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

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Allen, F., and Gale, G.. “Optimal Security Design.” Review of Financial Studies, 1 (1988), 229–263.CrossRefGoogle Scholar
Allen, F., and Gale, G.. Financial Innovation and Risk Sharing. Cambridge, MA: The M.I.T. Press (1994).Google Scholar
Allen, E., and Winton, A.. “Corporate Financial Structure, Incentives and Optimal Contracting.” Working Paper, Rodney L. White Center for Financial Research (06 1994).Google Scholar
Amihud, Y., and Mendelson, H.. “Asset Pricing and the Bid-Ask Spread.” Journal of Financial Economics, 17 (1986), 223–249.CrossRefGoogle Scholar
Amihud, Y., and Mendelson, H.. “Liquidity and Asset Pricing: Financial Management Implications.” Financial Management, 17 (1988), 5–15.CrossRefGoogle Scholar
Amihud, Y., and Mendelson, H.. “Liquidity, Maturity, and the Yields on U.S. Treasury Securities.” Journal of Finance, 46 (1991), 1411–1425.CrossRefGoogle Scholar
Baxter, M., and Crucini, M.. “Business Cycles and the Asset Structure of Foreign Trade.” International Economic Review, 36 (1995), 821–854.CrossRefGoogle Scholar
Bhattacharya, S., and Pfleiderer, P.. “Delegated Portfolio Management.” Journal of Economic Theory, 36 (1985), 1–25.CrossRefGoogle Scholar
Boyd, J., and Smith, B.. “How Good are Standard Debt Contracts? Stochastic vs. Non-Stochastic Monitoring in a Costly State Verification Environment.” Journal of Business, 67 (1994), 539–561.CrossRefGoogle Scholar
Brealey, R., and Myers, S.. Principles of Corporate Finance, (4th ed.) New York, NY: McGraw Hill (1991).Google Scholar
Chiesa, G. “Debt and Warrants: Agency Problems and Mechanism Design.” Journal of Financial Intermediation, 1 (1992), 237–254.CrossRefGoogle Scholar
Conrad, J. “The Price Effect of Option Introduction.” Journal of Finance, 44 (1989), 487–498.CrossRefGoogle Scholar
Detemple, J., and Jorion, P.. “Option Listing and Stock Returns: An Empirical Analysis.” Journal of Banking and Finance, 14 (1990), 781–801.CrossRefGoogle Scholar
Dybvig, P., and Spatt, C.. “Agency and the Market for Mutual Fund Managers: The Principle of Preference Similarity.” Working Paper, Carnegie Mellon and Yale Univ. (03 1986).Google Scholar
Dye, R. A. “Optimal Monitoring Policies in Agencies.” Rand Journal of Economics, 17 (1986), 339–350.CrossRefGoogle Scholar
Ferrall, C., and Shearer, B.. “Incentives, Team Production, Transactions Costs and the Optimal Contract: Estimation of an Agency Model Using Payroll Records.” Working Paper, Queen's Univ. (08 1994).Google Scholar
Fluck, Z. “Optimal Financial Contracting: Debt versus Outside Equity.” Review of Financial Studies, 11 (1998), 383–418.CrossRefGoogle Scholar
Gale, D. “Standard Securities.” Review of Economic Studies, 59 (1992), 731–755.CrossRefGoogle Scholar
Gjesdal, F. “Piecewise Linear Incentive Schemes.” Scandinavian Journal of Economics, 90 (1988), 305–328.CrossRefGoogle Scholar
Green, R. C. “Investment Incentives, Debt, and Warrants.” Journal of Financial Economics, 13 (1984), 115–136.CrossRefGoogle Scholar
Grossman, S., and Hart, O.. “Corporate Financial Structure and Managerial Incentives.” In The Economics of Information and Uncertainty, McCall, J., ed. Chicago, IL: Chicago Univ. Press (1982).Google Scholar
Grossman, S., and Hart, O.. “An Analysis of the Principal Agent Problem.” Econometrica, 51 (1983), 7–46.CrossRefGoogle Scholar
Harris, M., and Raviv, A.. “Optimal Incentive Contracts with Imperfect Information.” Journal of Economic Theory, 20 (1979), 231–259.CrossRefGoogle Scholar
Haubrich, J. “Risk Aversion, Performance Pay, and the Principal-Agent Problem.” Journal of Political Economy, 102 (1994), 258–276.CrossRefGoogle Scholar
Heaton, J., and Lucas, D.. “Evaluating the Effects of Incomplete Markets on Risk Sharing and Asset Pricing.” Journal of Political Economy, 104 (1996), 443–487.CrossRefGoogle Scholar
Helwege, J., and Liang, N.. “Is There a Pecking Order? Evidence from a Panel of IPO Firms.” Journal of Financial Economics, 40 (1996), 429–458.CrossRefGoogle Scholar
Holmström, B. “Moral Hazard and Observability.” Bell Journal of Economics, 10 (1979), 74–91.CrossRefGoogle Scholar
Innés, R. “Limited Liability and Incentive Contracting with Ex-ante Action Choices.” Journal of Economic Theory, 52 (1990), 45–67.CrossRefGoogle Scholar
Jewitt, I. “Justifying the First-Order Approach to Principal Agent Problems.” Econometrica, 56 (1988), 1177–1190.CrossRefGoogle Scholar
Mehra, R., and Prescott, E. C.. “The Equity Premium: A Puzzle?” Journal of Monetary Economics, 15 (1985), 145–161.CrossRefGoogle Scholar
Morse, P., and Feshbach, H.. Methods of Theoretical Physics – 1. New York, NY: McGraw Hill (1953).Google Scholar
Petersen, M., and Rajan, R.. “The Benefits of Lending Relationships: Evidence from Small Business Data.” Journal of Finance, 49 (1994), 3–37.CrossRefGoogle Scholar
Robe, M. “How Costly are Limited Liability Rules?” Working Paper MR-02, Finance Research Center, McGill Univ. (11 1998).CrossRefGoogle Scholar
Ross, S. “On the Economic Theory of Agency and the Principle of Similarity.” In Essays on Economic Behavior under Uncertainty, Balch, , McFadden, , and Wu, , eds. North Holland (1974).Google Scholar
Royden, H. L.Real Analysis, 3rd ed.New York, NY: Macmillan (1988).Google Scholar
Stoughton, N. “Moral Hazard and the Portfolio Management Problem.” Journal of Finance, 48 (1993), 2009–2028.CrossRefGoogle Scholar
Sung, J. “Linearity with Project Selection and Controllable Diffusion Rate in Continuous-Time Principal-Agent Problems.” Rand Journal of Economics, 26 (1995), 720–743.CrossRefGoogle Scholar
Telmer, C. I. “Asset Pricing Puzzles and Incomplete Markets.” Journal of Finance, 48 (1993), 1803–1832.Google Scholar
Weisbach, M. “Outside Directors and CEO Turnover.” Journal of Financial Economics, 20 (1988), 431–460.CrossRefGoogle Scholar
Welch, K. D. “Bankruptcy, Debtor's Prison, and Collateral in Optimal Debt Contracts.” Working Paper, Univ. of Chicago (12 1995).Google Scholar
Williams, J. “Debt and Equity as Optimal Financial Contracts.” Working Paper, Univ. of British Columbia (11 1988).Google Scholar