Guarantee-Investment Combination Financing for Entrepreneurship

Abstract

Recently, a guarantee-investment combination financing mode (G-I mode) is popular in practice to support entrepreneurship. This paper considers an entrepreneur who has an option to invest in a project with growth option using G-I mode. We develop a pricing model and explicitly derive all corporate security values and optimal investment and default thresholds with fair guarantee. We show that growth investment options should be granted to insurers and otherwise, an underinvestment problem appears. We provide an optimal guarantee contract design method where guarantee fee might be negative. We therefore produce a novel explanation of why G-I mode is popular.