Financial Innovation and Delegation of Control

The literature on security design has traditionally assumed that control of investment and production rests with the entrepreneur even after flotation. In this article I relax this assumption, which is both unnecessarily strict and unrealistic. The contribution is twofold. First, I show that when control is delegated during flotation, financial innovation is a trade off between agency costs (arising from principal agent relationships) and targeting costs (arising from the inability to split the cash flow). Second, I show that unlevered equity or the use of debt which can be issued without defaulting in equilibrium, are optimal means of financing.