Working Paper: CEPR ID: DP10660
Authors: Paolo Fulghieri; Diego Garcia; Dirk Hackbarth
Abstract: We study a security design problem under asymmetric information, in the spirit of Myers and Majluf (1984). We introduce a new condition on the right tail of the firm-value distribution that determines the optimality of debt versus equity-like securities. When asymmetric information has a small impact on the right-tail, risky debt is preferred for low capital needs, but convertible debt is optimal for larger capital needs. In addition, we show that warrants are the optimal financing instruments when the firm has already pre-existing debt in its capital structure. Finally, we provide conditions that generate reversals of the standard pecking order.
Keywords: debt-equity choices; pecking order; asymmetric information; security design
JEL Codes: D82; G32
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| asymmetric information (D82) | optimal security choice (F52) |
| asymmetric information (D82) | right tail of the firm-value distribution (G32) |
| right tail of the firm-value distribution (G32) | risky debt optimal for low capital needs (G32) |
| right tail of the firm-value distribution (G32) | convertible debt preferred for larger capital needs (G32) |
| preexisting debt (F34) | warrants optimal (H21) |
| insiders better informed about assets in place (G14) | equity financing dominates debt financing (G32) |
| multiple asset classes (G19) | pecking order violated (D73) |
| asymmetric information impacts financing choices (D82) | implications of asymmetric information on financing choices (D82) |