Separating equilibria, underpricing and security design

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JournalJournal of Financial Economics
DateAccepted/In press - 20 Jul 2021
DateE-pub ahead of print (current) - 22 Jul 2022
DatePublished - 1 Sep 2022
Issue number3
Volume145
Number of pages14
Pages (from-to)788-801
Early online date22/07/22
Original languageEnglish

Abstract

Classical security design papers equate competitive capital markets to securities
being fairly priced in expectation. We revisit Nachman and Noe (1994)'s adverse-
selection setting, modeling capital-market competition as free entry of investors and allowing firms to propose prices for their securities, as happens in private securities placements and bank lending. We identify equilibria in which high types issue underpriced debt, which yields positive expected prots to uninformed lenders, while low types issue steeper securities, such as equity. In addition, pooling equilibria exist in which firms issue underpriced debt. Introducing pre-existing capital structures provides further foundations for pecking-order theories of external finance.

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© 2021 Elsevier B.V. This is an author-produced version of the published paper. Uploaded in accordance with the publisher’s self-archiving policy.

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