Financing Entrepreneurial Production: Security Design with Flexible Information Acquisition

Abstract

We propose a theory of security design in financing entrepreneurial production, positing that the investor can acquire costly information on the entrepreneur's project before making the financing decision. When the entrepreneur has enough bargaining power in security design, the optimal security helps incentivize both efficient information acquisition and efficient financing. Debt is optimal when information is not very valuable for production, whereas the combination of debt and equity is optimal when information is valuable. If, instead, the investor has sufficiently strong bargaining power in security design or can acquire information only after financing, equity is optimal. (JEL D82, D86, G24, G32, L26) * We thank Itay Goldstein (the Editor), two referees,

Optimality of Debt under Flexible Information Acquisition

“… 7 In this vein,Yang and Zeng (2018) consider a general production economy and argue that projects of di¤erent natures require di¤erent means of …nancing.1 8 This perturbation is feasible because b sq ( ) q > [g 0 (1) g 0 (p 1 )] > 0. This argument cannot be…”

Insider Investor and Information

“…We show convertible securities are also optimal under endogenous information design, thus demonstrating the robustness of earlier findings. Complementary is Yang and Zeng (2017) which shows that under flexible information acquisition by investors and when information is valuable, a combination of debt and equity is optimal for the entrepreneur.…”

“…Related isYang and Zeng (2017) that shows optimality of a combination of debt and a monotone security under investors' flexible information acquisition, through a different underlying mechanism.…”

Contracts for acquiring information

“…Motivated by the second force, the same conclusion is drawn by Dang et al (2012) and Yang (2015): debt contracts are optimal to securitize state-dependent cash-flows because they avoid trade-destroying information asymmetry between the buyer and seller. Other examples include Crémer and Khalil (1992), Cremer et al (1998), Yang and Zeng (2015).…”