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Dynamic Investment and Financing under Asymmetric Information

Author

Listed:
  • Erwan MORELLEC

    (Ecole Polytechnique Federale de Lausanne (EPFL), Swiss Finance Institute and CEPR)

  • Norman SCHURHOFF

    (University of Lausanne and Swiss Finance Institute)

Abstract

This 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.

Suggested Citation

  • Erwan MORELLEC & Norman SCHURHOFF, 2009. "Dynamic Investment and Financing under Asymmetric Information," Swiss Finance Institute Research Paper Series 09-09, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp0909
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    File URL: http://ssrn.com/abstract=1368272
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    Cited by:

    1. Priyank Gandhi, 2018. "The relation between bank credit growth and the expected returns of bank stocks," European Financial Management, European Financial Management Association, vol. 24(4), pages 610-649, September.
    2. Albertus, James F. & Glover, Brent & Levine, Oliver, 2022. "Foreign investment of US multinationals: The effect of tax policy and agency conflicts," Journal of Financial Economics, Elsevier, vol. 144(1), pages 298-327.

    More about this item

    Keywords

    asymmetric information; financing decisions; investment timing;
    All these keywords.

    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

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