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Asymmetric Information concerning the Variance of Cash Flows: The Capital Structure Choice

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  • Brick, Ivan E
  • Frierman, Michael
  • Kim, Yu Kyung

Abstract

This paper assumes that a higher valued firm is distinguished from its lower valued counterpart by having a cash flow distribution with a lower variance. A separating (sequential) Nash equilibrium signaling model is developed in which firms use the levels of debt and dividends to convey information to the market regarding the variance of their underlying cash flow. In contrast to most, if not all, debt signaling models, the higher quality firm signals its value by issuing new equity (decreasing the leverage) while simultaneously offering cash dividends. Copyright 1998 by Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association.

Suggested Citation

  • Brick, Ivan E & Frierman, Michael & Kim, Yu Kyung, 1998. "Asymmetric Information concerning the Variance of Cash Flows: The Capital Structure Choice," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 39(3), pages 745-761, August.
    • Handle: RePEc:ier:iecrev:v:39:y:1998:i:3:p:745-61
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    Cited by:

    1. Miglo, Anton, 2010. "The Pecking Order, Trade-off, Signaling, and Market-Timing Theories of Capital Structure: a Review," MPRA Paper 46691, University Library of Munich, Germany, revised 2013.
    2. Alejandro Vargas Sanchez, 2014. "Estructura de capital Óptima en presencia de costos de dificultades financieras," Investigación & Desarrollo, Universidad Privada Boliviana, vol. 1(1), pages 44-66.
    3. Miglo, Anton, 2021. "A New Capital Structure Theory: The Four-Factor Model," MPRA Paper 105102, University Library of Munich, Germany.
    4. Ordoñez, Guillermo & Perez-Reyna, David & Yogo, Motohiro, 2019. "Leverage dynamics and credit quality," Journal of Economic Theory, Elsevier, vol. 183(C), pages 183-212.
    5. Miglo, Anton, 2017. "Timing of earnings and capital structure," The North American Journal of Economics and Finance, Elsevier, vol. 40(C), pages 1-15.
    6. Miglo, Anton, 2007. "Debt-equity choice as a signal of earnings profile over time," The Quarterly Review of Economics and Finance, Elsevier, vol. 47(1), pages 69-93, March.
    7. Huang, Ying Sophie & Wang, Chia-Jane, 2015. "Corporate governance and risk-taking of Chinese firms: The role of board size," International Review of Economics & Finance, Elsevier, vol. 37(C), pages 96-113.
    8. Miglo, Anton, 2012. "Multi-stage investment, long-term asymmetric information and equity issues," MPRA Paper 46692, University Library of Munich, Germany.
    9. Gabrielle Wanzenried, 2002. "Signaling with Capital Structure Revisited," Diskussionsschriften dp0214, Universitaet Bern, Departement Volkswirtschaft.
    10. Miglo, Anton & Zenkevich, Nikolay, 2005. "Non-hierarchical signalling: two-stage financing game," MPRA Paper 1264, University Library of Munich, Germany, revised 2006.
    11. Miglo, Anton, 2006. "Debt-equity choice as a signal of profit profile over time," MPRA Paper 1283, University Library of Munich, Germany.
    12. Anton Miglo, 2006. "Optimal compensation contracts under asymmetric information concerning expected earnings," Working Papers 0613, University of Guelph, Department of Economics and Finance.

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