DP15193 Security Design with Status Concerns

Author(s):	Suleyman Basak, Dmitry Makarov, Alex Shapiro, Marti G. Subrahmanyam
Publication Date:	August 2020
Keyword(s):	Convertible Securities, Financing, hybrid securities, security design, Status concerns
JEL(s):	C61, D86, G24, G32
Programme Areas:	Financial Economics
Link to this Page:	cepr.org/active/publications/discussion_papers/dp.php?dpno=15193

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, accentuate incentives to issue convertible securities. We also provide analytical results relevant to quantifying how status concerns affect credit risk, an established factor behind security choic