TY - JOUR
T1 - Asset substitution and structured financing
AU - Vanden, Joel M.
N1 - Funding Information:
∗Vanden, [email protected], Smeal College of Business, Pennsylvania State University, 341 Business Bldg., University Park, PA 16802. I thank Paul Childs and Nengjiu Ju (the referees) and Paul Malatesta (the editor). I also thank the seminar participants at Boston University, University of North Carolina at Chapel Hill, Bank of Canada, Georgia Tech, University of Georgia, Indiana University, Virginia Tech, Michigan State University, and Pennsylvania State University for helpful comments. Research support from the Tuck School of Business is gratefully acknowledged. Any errors are mine.
PY - 2009/8
Y1 - 2009/8
N2 - This article shows how structured financing can be used to solve the asset substitution problem in a dynamic setting. Structuring induces the firms owner to optimally choose the first best operating strategy even though the owners value function might be locally convex (concave), which would ordinarily lead to overinvestment (underinvestment) in risky projects. This result is demonstrated in two different continuous time settingsone that is based on the risk-shifting framework of Leland (1998) and one that generalizes the scaled return model of Green (1984). It is shown that the contractual nature of the structuring is a key determinant of the issuing firms dynamic asset volatility. Furthermore, unlike nonstructured financing, the default (conversion) probability of a structured debt security may be increasing (decreasing) in the firms total assets. Structured securities are therefore hedge assets, which potentially explains the popularity of structured securities among investors and third-party issuers.
AB - This article shows how structured financing can be used to solve the asset substitution problem in a dynamic setting. Structuring induces the firms owner to optimally choose the first best operating strategy even though the owners value function might be locally convex (concave), which would ordinarily lead to overinvestment (underinvestment) in risky projects. This result is demonstrated in two different continuous time settingsone that is based on the risk-shifting framework of Leland (1998) and one that generalizes the scaled return model of Green (1984). It is shown that the contractual nature of the structuring is a key determinant of the issuing firms dynamic asset volatility. Furthermore, unlike nonstructured financing, the default (conversion) probability of a structured debt security may be increasing (decreasing) in the firms total assets. Structured securities are therefore hedge assets, which potentially explains the popularity of structured securities among investors and third-party issuers.
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U2 - 10.1017/S0022109009990226
DO - 10.1017/S0022109009990226
M3 - Article
AN - SCOPUS:77049124768
SN - 0022-1090
VL - 44
SP - 911
EP - 951
JO - Journal of Financial and Quantitative Analysis
JF - Journal of Financial and Quantitative Analysis
IS - 4
ER -