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Asset Substitution and Structured Financing

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  • Vanden, Joel M.

Abstract

This article shows how structured financing can be used to solve the asset substitution problem in a dynamic setting. Structuring induces the firm’s owner to optimally choose the first best operating strategy even though the owner’s 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 settings—one 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 firm’s dynamic asset volatility. Furthermore, unlike nonstructured financing, the default (conversion) probability of a structured debt security may be increasing (decreasing) in the firm’s total assets. Structured securities are therefore hedge assets, which potentially explains the popularity of structured securities among investors and third-party issuers.

Suggested Citation

  • Vanden, Joel M., 2009. "Asset Substitution and Structured Financing," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(4), pages 911-951, August.
    • Handle: RePEc:cup:jfinqa:v:44:y:2009:i:04:p:911-951_99
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    Cited by:

    1. Kuersten, Wolfgang & Linde, Rainer, 2011. "Corporate hedging versus risk-shifting in financially constrained firms: The time-horizon matters!," Journal of Corporate Finance, Elsevier, vol. 17(3), pages 502-525, June.
    2. Kürsten, Wolfgang, 2013. "35 Jahre Jensen/Meckling und das Missverständnis um die (wahre) Zielfunktion der Aktionäre – Finanzierungstheoretisches Plädoyer zur Eignung der Principal-Agent-Theorie für die Lösung von Problemen de," Die Unternehmung - Swiss Journal of Business Research and Practice, Nomos Verlagsgesellschaft mbH & Co. KG, vol. 67(1), pages 8-22.
    3. Liu, Sun & Zhang, Jie, 2023. "Conditional conservatism and investment efficiency under a state ownership environment: Further evidence from China," Journal of International Accounting, Auditing and Taxation, Elsevier, vol. 53(C).

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