Optimal Security Design under Asymmetric Information and Profit Manipulation

Research output: Contribution to journalArticlepeer-review

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Optimal Security Design under Asymmetric Information and Profit Manipulation. / Koufopoulos, Konstantinos; Kozhan, Roman; Trigilia, Giulio.

In: Review of Corporate Finance Studies, Vol. 8, No. 1, 01.03.2019, p. 146–173.

Research output: Contribution to journalArticlepeer-review

Harvard

Koufopoulos, K, Kozhan, R & Trigilia, G 2019, 'Optimal Security Design under Asymmetric Information and Profit Manipulation', Review of Corporate Finance Studies, vol. 8, no. 1, pp. 146–173. https://doi.org/10.1093/rcfs/cfy008

APA

Koufopoulos, K., Kozhan, R., & Trigilia, G. (2019). Optimal Security Design under Asymmetric Information and Profit Manipulation. Review of Corporate Finance Studies, 8(1), 146–173. https://doi.org/10.1093/rcfs/cfy008

Vancouver

Koufopoulos K, Kozhan R, Trigilia G. Optimal Security Design under Asymmetric Information and Profit Manipulation. Review of Corporate Finance Studies. 2019 Mar 1;8(1):146–173. https://doi.org/10.1093/rcfs/cfy008

Author

Koufopoulos, Konstantinos ; Kozhan, Roman ; Trigilia, Giulio. / Optimal Security Design under Asymmetric Information and Profit Manipulation. In: Review of Corporate Finance Studies. 2019 ; Vol. 8, No. 1. pp. 146–173.

Bibtex - Download

@article{9e9f1dbab5e04a8e8d35e8e0b0c17de2,
title = "Optimal Security Design under Asymmetric Information and Profit Manipulation",
abstract = "We consider a model of external financing in which entrepreneurs are privatelyinformed about the quality of their projects and seek funds from competitive financiers. The literature restricts attention to monotonic, or “manipulation proof,” securities and finds that straight debt is the uniquely optimal contract. Monotonicity is commonly justified by the argument that it would endogenously arise if the entrepreneur can window dress the realized earnings before contract maturity. We explicitly characterize the optimal contracts when entrepreneurs engage in window dressing and/or output diversion and derive necessary and sufficient conditions for straight debt to be optimal. Contrary to conventional wisdom, debt is often suboptimal, and it is never uniquely optimal. Optimal contracts are nonmonotonic and induce profit manipulation in equilibrium. They can be implemented as performance-sensitive debt.",
keywords = "security design, capital structure, asymmetric information, profi t manipulation, window dressing",
author = "Konstantinos Koufopoulos and Roman Kozhan and Giulio Trigilia",
note = "{\textcopyright} The Author(s) 2018. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. This is an author-produced version of the published paper. Uploaded in accordance with the publisher{\textquoteright}s self-archiving policy. Further copying may not be permitted; contact the publisher for details.",
year = "2019",
month = mar,
day = "1",
doi = "10.1093/rcfs/cfy008",
language = "English",
volume = "8",
pages = "146–173",
journal = "Review of Corporate Finance Studies",
number = "1",

}

RIS (suitable for import to EndNote) - Download

TY - JOUR

T1 - Optimal Security Design under Asymmetric Information and Profit Manipulation

AU - Koufopoulos, Konstantinos

AU - Kozhan, Roman

AU - Trigilia, Giulio

N1 - © The Author(s) 2018. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. This is an author-produced version of the published paper. Uploaded in accordance with the publisher’s self-archiving policy. Further copying may not be permitted; contact the publisher for details.

PY - 2019/3/1

Y1 - 2019/3/1

N2 - We consider a model of external financing in which entrepreneurs are privatelyinformed about the quality of their projects and seek funds from competitive financiers. The literature restricts attention to monotonic, or “manipulation proof,” securities and finds that straight debt is the uniquely optimal contract. Monotonicity is commonly justified by the argument that it would endogenously arise if the entrepreneur can window dress the realized earnings before contract maturity. We explicitly characterize the optimal contracts when entrepreneurs engage in window dressing and/or output diversion and derive necessary and sufficient conditions for straight debt to be optimal. Contrary to conventional wisdom, debt is often suboptimal, and it is never uniquely optimal. Optimal contracts are nonmonotonic and induce profit manipulation in equilibrium. They can be implemented as performance-sensitive debt.

AB - We consider a model of external financing in which entrepreneurs are privatelyinformed about the quality of their projects and seek funds from competitive financiers. The literature restricts attention to monotonic, or “manipulation proof,” securities and finds that straight debt is the uniquely optimal contract. Monotonicity is commonly justified by the argument that it would endogenously arise if the entrepreneur can window dress the realized earnings before contract maturity. We explicitly characterize the optimal contracts when entrepreneurs engage in window dressing and/or output diversion and derive necessary and sufficient conditions for straight debt to be optimal. Contrary to conventional wisdom, debt is often suboptimal, and it is never uniquely optimal. Optimal contracts are nonmonotonic and induce profit manipulation in equilibrium. They can be implemented as performance-sensitive debt.

KW - security design

KW - capital structure

KW - asymmetric information

KW - profit manipulation

KW - window dressing

U2 - 10.1093/rcfs/cfy008

DO - 10.1093/rcfs/cfy008

M3 - Article

VL - 8

SP - 146

EP - 173

JO - Review of Corporate Finance Studies

JF - Review of Corporate Finance Studies

IS - 1

ER -