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Pecking order of convertible security financing for start-up ventures and overinvestment

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  • Shimizu, Makoto

Abstract

This study develops a parsimonious theoretical model to investigate the pecking order in financing for start-up ventures, especially with convertible securities, under adverse selection where a firm’s investment possibly has a negative value. While the role of convertible securities is limited and the cross-subsidy enables inefficient business in the competitive market, the signaling in relationship financing prevents inefficient investment and convertible securities are useful in situations with more volatile cash flow distributions. Considering the interrelation between competitive markets and relationship financing without investors’ monopolistic positions, signaling with convertible securities from profitable firms is likely to occur when market conditions are uncertain or the economy is stagnant, thereby possibly explaining boom and bust.

Suggested Citation

  • Shimizu, Makoto, 2023. "Pecking order of convertible security financing for start-up ventures and overinvestment," The North American Journal of Economics and Finance, Elsevier, vol. 68(C).
    • Handle: RePEc:eee:ecofin:v:68:y:2023:i:c:s1062940823000980
    DOI: 10.1016/j.najef.2023.101975
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    References listed on IDEAS

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    1. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
    2. Nachman, David C & Noe, Thomas H, 1994. "Optimal Design of Securities under Asymmetric Information," The Review of Financial Studies, Society for Financial Studies, vol. 7(1), pages 1-44.
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    More about this item

    Keywords

    Convertible security; Pecking-order; Adverse selection; Overinvestment; Venture financing;
    All these keywords.

    JEL classification:

    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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