Security Design with Status Concerns
48 Pages Posted: 29 Jan 2015 Last revised: 25 Aug 2019
Date Written: August 22, 2019
This paper provides a status-based explanation for convertible securities. An entrepreneur with status concerns inducing risk-taking decides how to finance the firm and how to dynamically manage it. Solving analytically for the optimal security, we find that it is substantially similar to a convertible security. Our model can explain why convertible securities are mainly issued by start-ups and small firms, as we show that their salient characteristics, higher volatility and dynamic flexibility, increase incentives to issue convertible securities. We also provide analytical results relevant to quantifying how status concerns affect credit risk, an established factor behind security choice.
Keywords: Security Design, Status Concerns, Convertible Securities, Financing, Hybrid Securities
JEL Classification: G32, C61, G24, D86
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