With Mark Jansen and Thomas Noe
Informal Abstract: Theoretical paper showing that if there is information asymmetry (the seller knows more about what he is selling) and optimism (the buyer thinks she will add value; they both agree on that but buyer thinks she will add more than what the seller thinks), then asking the seller to provide a loan to the buyer is a great idea. Much better than asking the seller to keep a stake in the company; even when the buyer is not financially constrained. However, if the buyer is too optimistic in her ability to add value, she will not ask for that loan, and will pay with cash only.
Formal Abstract: We propose a security design model in which a potential acquirer approaches a firm with a value-add plan. The target has a single owner, who possesses private information: he knows whether his firm is compatible with the plan, or not. The seller agrees the acquirer will add value but not as much as what the acquirer expects. Although the acquirer can choose any monotone limited liability security to offer along with cash, we show that, under general conditions, if a security is employed, it takes the form of non-recourse junior debt provided by the seller.