Optimal Security Design Under Asymmetric Information and Incomplete Contracts

This article analyzes the optimal design of securities in situations where ex-ante asymmetric information about a firm`s current profit is symmetric and that about future profit is asymmetric. Also a complete contract contingeant on a future profit is impossible to write except establishing residual property rights. The analysis shows that for the best type of firm an optimal contract would have maximal residual ownership rights under low values of first-period earnings and minimal residual ownership rights under high values of first-period earnings. In economic terms this corresponds to debt