Optimal Versus Traditional Securities Under Moral Hazard
Posted: 22 Mar 1999 Last revised: 13 Nov 2009
Date Written: 1999
Abstract
We provide an explanation of 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. We 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.
JEL Classification: G31, G32
Suggested Citation: Suggested Citation