Working Paper: NBER ID: w18677
Authors: Alex Edmans; William Mann
Abstract: Most research on firm financing studies the choice between debt and equity. We model an alternative source - non-core asset sales - and allow asset sales to occur for operational as well as financing motives. We identify three new factors that drive a firm's choice between selling assets and equity. First, equity investors own a claim to the cash raised. Since cash is certain, this mitigates the information asymmetry of equity (the "certainty effect"). In contrast to Myers and Majluf (1984), even if assets exhibit less information asymmetry, the firm issues equity if the financing need is high. This result is robust to using the cash for an uncertain investment. Second, firms can disguise the sale of a low-quality asset as instead being motivated by operational reasons (dissynergies), and thus receive a high price (the "camouflage effect"). Third, selling equity implies a "lemons" discount for not only the equity issued but also the rest of the firm, since its value is perfectly correlated. In contrast, a "lemons" discount on assets need not lead to a low stock price, as the asset is not a carbon copy of the firm (the "correlation effect").
Keywords: Asset Sales; Firm Financing; Information Asymmetry; Operational Motives
JEL Codes: G32; G34
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| equity investors face less information asymmetry due to the certainty effect (G14) | firms may choose to issue equity rather than sell assets (G32) |
| a sufficiently high financing need can lead to a pooling equilibrium where firms sell assets if the financing need is low, and equity if high (G32) | firms may choose to issue equity rather than sell assets (G32) |
| the camouflage effect (C92) | firms with low-quality assets can disguise their sales as operationally motivated, thus enabling them to achieve higher sale prices (L21) |
| the correlation effect (C10) | when firms issue equity, they incur a lemons discount that negatively impacts the valuation of the entire firm (G32) |
| higher financing needs may reduce asset sales as firms substitute into equity (G32) | improve real efficiency by retaining synergistic assets (L21) |