Capital Structure with Information about the Upside and the Downside

Chaigneau, Pierre (2023): Capital Structure with Information about the Upside and the Downside. Forthcoming in: Journal of Financial and Quantitative Analysis

Abstract

We introduce two dimensions of uncertainty, about the upside and the downside of an asset, in a model of asset valuation under asymmetric information. This justifies capital structures with equity and risky debt for information revelation purposes. However, a capital structure with only one information-sensitive security, equity, can be optimal when investors are less informed about the dimension that matters more for valuation. This is relevant for innovative firms with a large upside subject to strong information asymmetries, which often have abnormally low leverage, and for firms at an intermediate stage of their life cycle that don't issue risky debt.

• Item Type: MPRA Paper
• Language: English
• Keywords: capital structure, downside risk, security design, tranching, upside potential
• Subjects: G - Financial Economics > G1 - General Financial Markets > G11 - Portfolio Choice ; Investment Decisions; G - Financial Economics > G1 - General Financial Markets > G14 - Information and Market Efficiency ; Event Studies ; Insider Trading

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