Two-Sided Asymmetric Information and Convertible Securities in Venture Financing
16 Pages Posted: 20 Nov 2018
Date Written: October 17, 2018
This paper presents a new explanation for the prevalence of convertible bond in venture capital finance. By modeling two-sided asymmetric information between entrepreneurs and venture capitalists, we prove that convertible bond can implement the optimal contract. The optimal conversion ratio increases when it's more difficult to attract a venture capitalist, and it also increases with the extent of adverse selection in the venture capitalist market. Our model also predicts that the optimal conversion ratio is negatively correlated with the competition in VC market and the level of VC's human capital.
Keywords: Start-Up Financing, Information Asymmetry, Convertible Security, Venture Capital
JEL Classification: D82, G24, G32
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