AUTONOMY-BASED SECURITY DESIGN: THE ALLOCATION OF CASH FLOW AND CONTROL RIGHTS

We derive debt, equity, convertible debt and asset-backed debt securities as optimal security designs in an environment in which the owner-manager has an endogenous control preference – a desire for autonomy – arising from the anticipation of future disagreement with investors over a value-maximizing project choice. This disagreement is engendered not by agency or asymmetric information problems but by heterogeneous rational beliefs about the precision of a public signal of project value. Optimal security design seeks to simultaneously achieve an efficient allocation of cash-flow sharing rights and control rights over project choice. In some circumstances, the optimal security design involves a linear cash-flow sharing rule and joint control between the manager and investors, resembling common equity. In fact, whenever joint control is efficient, the optimal security is always equity. In other circumstances, the optimal security design involves promising investors a fixed amount, with exclusive managerial control. This resembles riskless debt in some circumstances and risky debt in others. We also identify the circumstances in which con-vertible debt is the optimal security, and when it will be efficient for the firm to segregate (securitize) a group of assets and then issue a debt claim against those assets as in the case of asset-backed commercial paper. Our analysis also explains why firms tend to issue equity when their stock prices are high