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Tests of a Signaling Hypothesis: The Choice between Fixed- and Adjustable-Rate Debt

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  • Guedes, Jose
  • Thompson, Rex

Abstract

We develop a model wherein the choice between adjustable- and fixed-rate debt can serve as a signal of firm quality. The nature of the signal depends on expected inflation volatility relative to other risk parameters. Evidence from a matched sample of debt announcements over the period 1978 to 1986 shows a difference of [minus]2.05 percent between stock price reactions to adjustable rate and fixed rate announcements when expected inflation volatility is above an estimated threshold. Below this threshold, the difference is [plus]0.98 percent. The evidence supports the hypothesis that the riskier debt choice serves as a favorable signal of firm quality. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.

Suggested Citation

  • Guedes, Jose & Thompson, Rex, 1995. "Tests of a Signaling Hypothesis: The Choice between Fixed- and Adjustable-Rate Debt," The Review of Financial Studies, Society for Financial Studies, vol. 8(3), pages 605-636.
    • Handle: RePEc:oup:rfinst:v:8:y:1995:i:3:p:605-36
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    Cited by:

    1. Vickery, James, 2008. "How and why do small firms manage interest rate risk," Journal of Financial Economics, Elsevier, vol. 87(2), pages 446-470, February.
    2. Lisa L. Posey & Paul D. Thistle, 2017. "Automobile Insurance and Driver Ability: Contract Choice as a Screening Mechanism," The Geneva Risk and Insurance Review, Palgrave Macmillan;International Association for the Study of Insurance Economics (The Geneva Association), vol. 42(2), pages 141-170, September.
    3. Lisa L. Posey & Paul D. Thistle, 2017. "Automobile Insurance and Driver Ability: Contract Choice as a Screening Mechanism," The Geneva Papers on Risk and Insurance Theory, Springer;International Association for the Study of Insurance Economics (The Geneva Association), vol. 42(2), pages 141-170, September.
    4. James Vickery, 2005. "How and why do small firms manage interest rate risk? Evidence from commercial loans," Staff Reports 215, Federal Reserve Bank of New York.
    5. Oberoi, Jaideep, 2018. "Interest rate risk management and the mix of fixed and floating rate debt," Journal of Banking & Finance, Elsevier, vol. 86(C), pages 70-86.
    6. Ajay Kalra & Shibo Li, 2008. "Signaling Quality Through Specialization," Marketing Science, INFORMS, vol. 27(2), pages 168-184, 03-04.
    7. Posey, Lisa L. & Yavas, Abdullah, 2001. "Adjustable and Fixed Rate Mortgages as a Screening Mechanism for Default Risk," Journal of Urban Economics, Elsevier, vol. 49(1), pages 54-79, January.
    8. Chava, Sudheer & Purnanandam, Amiyatosh, 2007. "Determinants of the floating-to-fixed rate debt structure of firms," Journal of Financial Economics, Elsevier, vol. 85(3), pages 755-786, September.

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