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Optimal Financial Contracts for a Start-Up with Unlimited Operating Discretion

Published online by Cambridge University Press:  06 April 2009

S. Abraham Ravid  and
Matthew Spiegel
S. Abraham Ravid
Affiliation:
Faculty of Management, Rutgers University, 81 New Street, Newark, NJ 07102
Matthew Spiegel
Affiliation:
Haas School of Business, 545 Student Services Building #1900, University of California at Berkeley, Berkeley, CA 94720
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Abstract

The model presented here shows that extreme uncertainty between an entrepreneur and potential investors can lead to the exclusive use of equity and riskless debt for small business financing. The paper derives these results without any restrictions on the available contract space, the distribution function governing a project's payoff, or the risk aversion of most potential entrepreneurs. In addition, the model produces predictions regarding the “under-pricing”; of securities to outside financiers, the order in which firms will issue securities, and the relationship between the types of securities a firm will issue and its available collateral.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 32 , Issue 3 , September 1997 , pp. 269 - 286
Copyright
Copyright © School of Business Administration, University of Washington 1997

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