The Optimal Structure of Securities under Coordination Frictions

We study multi-agent security design in the presence of coordination frictions. A principal intends to develop a project whose value increases with an unknown state and the level of agents’ participation. To motivate the participation of ex-ante homogeneous agents, the principal offers them multiple monotone securities backed by the project value. More participation results in a higher project value and thus higher security payment to participating agents, making participation decisions strategic complements. Miscoordination arises because agents cannot precisely infer others’ decisions from noisy signals about the state. We identify two objects in security design—"payoff sensitivity" and "perception of participation"—that determine the impact of miscoordination. To mitigate the adverse impact of miscoordination, the two objects should be matched assortatively over agents. This mechanism implies a multi-tranche security structure in which senior-tranche holders are more robust to potential miscoordination and participate more aggressively, helping alleviate the junior-tranche holders’ fear of miscoordination. We find that the principal’s ability to differentiate agents in security format is crucial to whether differentiation is desirable