Optimal Versus Traditional Securities Under Moral Hazard

Posted: 22 Mar 1999 Last revised: 13 Nov 2009

See all articles by Michel A. Robe

Michel A. Robe

University of Richmond - E. Claiborne Robins School of Business

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

Robe, Michel A., Optimal Versus Traditional Securities Under Moral Hazard (1999). Journal of Financial and Quantitative Analysis, Vol. 34, No. 2, June, 1999, Available at SSRN: https://ssrn.com/abstract=156323

Michel A. Robe (Contact Author)

University of Richmond - E. Claiborne Robins School of Business ( email )

Richmond, VA 23173
United States

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