Dynamic Investment and Financing under Asymmetric Information
AbstractThis paper develops a tractable real options framework to analyze the effects of asymmetric information on investment and financing decisions when firms require external funds to finance investment. Our analysis shows that corporate insiders can signal their private information to outside investors using the timing of investment and the firm's debt-equity mix. Several important contributions follow from this result. First, we show that firms' equilibrium investment strategies differ significantly from those implied by standard real options models with perfect information. In particular, informational asymmetries erode the option value of waiting to invest and induce firms with good prospects to speed up investment, leading to overinvestment. Second, we demonstrate that informational asymmetries may not translate into a financing hierarchy. Most notably, we find that equity issues can be more attractive than debt issues even for firms with ample debt capacity, providing a rationale for the stylized fact that small high-growth firms do not behave according to the pecking order theory.
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Bibliographic InfoPaper provided by Swiss Finance Institute in its series Swiss Finance Institute Research Paper Series with number 09-09.
Length: 52 pages
Date of creation: Mar 2009
Date of revision:
asymmetric information; financing decisions; investment timing;
Find related papers by JEL classification:
- G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
- G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
- G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
- G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
This paper has been announced in the following NEP Reports:
- NEP-ALL-2009-06-03 (All new papers)
- NEP-BEC-2009-06-03 (Business Economics)
- NEP-CFN-2009-06-03 (Corporate Finance)
- NEP-CTA-2009-06-03 (Contract Theory & Applications)
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