Screening with Securities

Nicolas Inostroza, Nicolas Figueroa - Apr 26, 2023

Working Paper No.  00097-00

A liquidity-constrained asset owner designs an asset-backed security to raise funds from an informed liquidity supplier. Information insensitive securities reduce the liquidity supplier's informational rents. The issuer optimally screens the liquidity supplier's private information by offering a menu of debt contracts with face values monotonically ordered in the liquidity supplier's valuation. We leverage this characterization to show that when the liquidity supplier's private information becomes more accurate (Lehmann (1988)), the issuer optimally offers debt contracts with smaller face values. Surprisingly, the concavity of debt on the asset's future cashflows implies that the issuer may be better off when trading with a more informed liquidity supplier. Our results challenge the idea that, when trading securities, the informed party should obtain an information sensitive security and provide a novel rationale for the emergence of venture debt and the prevalence of collateralized lending.

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trading costs delegation filtering security design Optimal Screening information Lehmann ordering