Using Put Warrants to Reduce Corporate Financing Costs

Abstract:     
We show that put warrants can reduce financing costs when managers know more about the firm's future prospects than do outside investors. Put warrants are shown to be an efficient security in eliminating adverse selection costs in that firms can credibly reveal favorable private information without having to resort to "money burning" or inefficient investment decisions. Among the model's implications are that (i) put warrants are effective whether or not they are attached directly to equity shares, (ii) the number of puts issued must exceed the number of new shares issued, and (iii) a ceiling exists on the amount of project financing that a firm can successfully raise. Additionally our analysis provides practical insights into how the size and exercise price of the put warrant offering affect issues such as corporate control and the probability of default.

Number of Pages in PDF File: 43

JEL Classification: G32

working papers series