Security Design with Investor Private Information



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    • Axelson is with the Stockholm School of Economics and Swedish Institute for Financial Research. I am especially grateful to an anonymous referee whose comments substantially improved the paper. I also want to thank Nick Barberis, Philip Bond, Peter DeMarzo, Doug Diamond, Matt Jackson, Ilan Kremer, Robert McDonald, and Per Stromberg for many helpful comments, as well as seminar participants at Carnegie Mellon University, Duke University, Stockholm School of Economics, University of Chicago, University of Minnesota, Washington University in St. Louis, the AFA meetings, the NBER corporate finance meetings, and the Chicago–Minnesota Accounting Theory Conference.


I study the security design problem of a firm when investors rather than managers have private information about the firm. I find that it is often optimal to issue information-sensitive securities such as equity. The “folklore proposition of debt” from traditional signaling models only goes through if the firm can vary the face value of debt with investor demand. When the firm has several assets, debt backed by a pool of assets is optimal when the degree of competition among investors is low, while equity backed by individual assets is optimal when competition is high.