Costly State Verification and Multiple Investors: The Role of Seniority

Posted: 26 Oct 1999

See all articles by Andrew Winton

Andrew Winton

University of Minnesota - Twin Cities - Carlson School of Management; Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF)

Abstract

Many financial claims specify fixed maximum payments, varying seniority, and absolute priority for more senior investors. These features are motivated in a model where a firm's manager contracts with several investors and firm output can only be verified privately at a cost. Debt-like contracts of varying seniority generally dominate symmetric contracts, and when investors are risk neutral, it is optimal to use debt-like contracts where more senior claims have absolute priority over more junior claims. In addition to motivating several features of debt and preferred stock, the model offers an explanation for structures used in leverages buy-outs, asset-backed securitizations, and reinsurance contracts.

JEL Classification: G32

Suggested Citation

Winton, Andrew, Costly State Verification and Multiple Investors: The Role of Seniority. REVIEW OF FINANCIAL STUDIES, Volume 8 Issue 1. Available at SSRN: https://ssrn.com/abstract=5593

Andrew Winton (Contact Author)

University of Minnesota - Twin Cities - Carlson School of Management ( email )

321 19th Avenue South
Department of Finance
Minneapolis, MN 55455
United States
612-624-0589 (Phone)
612-626-1335 (Fax)

Shanghai Jiao Tong University (SJTU) - Shanghai Advanced Institute of Finance (SAIF) ( email )

Shanghai Jiao Tong University
211 West Huaihai Road
Shanghai, 200030
China

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