OPTIMAL FINANCIAL CONTRACTS FOR A START-UP WITH UNLIMITED OPERATING DISCRETION

The model presented here shows that extreme uncertainty between an ent repreneur and potential investors can lead to the exclusive use of equ ity and riskless debt for small business financing, The paper derives these results without any restrictions on the available contract space , the distribution function governing a project's payoff, or the risk aversion of most potential entrepreneurs. In addition, the model produ ces predictions regarding the ''underpricing'' of securities to outsid e financiers, the order in which firms will issue securities, and the relationship between the types of securities a firm will issue and its available collateral.