We construct a single-stage startup financing model, in which the entrepreneur strategically chooses debt-equity ratio as a signaling device in order to inform his project value to the investors. In our model, there is a penniless entrepreneur who plans an innovative project and he seeks for seed investment to launch the project. Based on the entrepreneur’s choice of capital structure, investors evaluate the project value. In particular, debt investors determine required return while equity investors ask their equity share for a given amount of investment. We allow for endogenous probability of bankruptcy which increases in the amount of debt as in Ross (1977).
KEYWORDS: principal-agent problem; executive compensation; information acquisition; price informativeness; price volatility
JEL CLASSIFICATION: G14, G24, D82
