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Asymmetric information, disagreement, and the valuation of debt and equity

Author

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  • Banerjee, Snehal
  • Breon-Drish, Bradyn
  • Smith, Kevin

Abstract

We study debt and equity valuation when investors have private information and may exhibit differences of opinion. Our model generates several predictions that are consistent with empirical evidence but difficult to reconcile with traditional models. Belief dispersion relates to expected equity and debt returns in opposite directions. Similarly, expected debt (equity) returns typically increase (decrease) with default risk, though these relationships reverse for firms close to bankruptcy. Firms’ capital structures affect their valuations even without classical capital structure frictions (e.g., tax shields, distress costs) – when liquidity is higher in the equity than in the debt market, leverage can raise firm value.

Suggested Citation

  • Banerjee, Snehal & Breon-Drish, Bradyn & Smith, Kevin, 2025. "Asymmetric information, disagreement, and the valuation of debt and equity," Journal of Financial Economics, Elsevier, vol. 165(C).
  • Handle: RePEc:eee:jfinec:v:165:y:2025:i:c:s0304405x25000030
    DOI: 10.1016/j.jfineco.2025.103995
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    More about this item

    Keywords

    Capital structure; Rational expectations; Difference of opinions; Disagreement; Liquidity trading; Information quality;
    All these keywords.

    JEL classification:

    • G10 - Financial Economics - - General Financial Markets - - - General (includes Measurement and Data)
    • G12 - Financial Economics - - General Financial Markets - - - Asset Pricing; Trading Volume; Bond Interest Rates
    • G14 - Financial Economics - - General Financial Markets - - - Information and Market Efficiency; Event Studies; Insider Trading
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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