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Continuous Signaling Within Partitions: Capital Structure and the FIFO/LIFO Choice

Author

Listed:
  • Patricia J. Hughes

    (University of Southern California)

  • Eduardo S. Schwartz

    (University of California, Los Angeles)

  • Anjan V. Thakor

    (Washington University in St. Louis)

Abstract

This paper considers a setting in which managers have private information about the values of their firms and can communicate it to uninformed investors through the use of two signals: capital structure and inventory accounting method. We show conditions under which a separating equilibrium with debt alone does not exist. The two-signal equilibrium involves a partitioned separation in which the highest quality firms choose FIFO and the lower quality firms choose LIFO, and all firms then distinguish themselves with these two partitions through capital structure choices. The analysis helps to explain the many observed empirical regularities about firms' capital structure choices and LIFO/FIFO choices and, in addition, produces numerous testable predictions about the relation between capital structure and inventory accounting method.

Suggested Citation

  • Patricia J. Hughes & Eduardo S. Schwartz & Anjan V. Thakor, 2004. "Continuous Signaling Within Partitions: Capital Structure and the FIFO/LIFO Choice," Finance 0411054, University Library of Munich, Germany.
    • Handle: RePEc:wpa:wuwpfi:0411054
    Note: Type of Document - pdf; pages: 19
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    File URL: https://econwpa.ub.uni-muenchen.de/econ-wp/fin/papers/0411/0411054.pdf
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    References listed on IDEAS

    as
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    • G - Financial Economics

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