Security Design with Interim Public Information

We consider a security design problem where public information about the security's underlying cash-flow arrives between trading periods. The optimal security minimizes less-than-full realization of gains from trade due to limited cash in the market, which may depend on the interim information. We show that the optimal security can be expressed as a convex combination of securities solving minimization problems for which the solutions share many debt-like features but exhibit endogenous tranching. We provide conditions for the non-optimality of standard debt contracts and show that implementation of the class of optimal securities can be achieved by mezzanine tranche retention, providing a public information rationale for departure from the pecking order