Debt-equity choice as a signal of profit profile over time

Miglo, Anton (2006): Debt-equity choice as a signal of profit profile over time.

Abstract

This paper analyzes debt-equity choice for financing a two-stage investment when a firm’s insiders have private information about the firm’s expected earnings. When private information is one-dimensional (for example when short-term earnings are common knowledge while long-term earnings are private information) a separating equilibrium does not exist. When private information is two-dimensional a separating equilibrium may exist where firms with a higher rate of earnings growth issue debt and firms with a low rate of earnings growth issue equity. This provides new insights into the issue of different kinds of securities by different types of firms under asymmetric information as well as the link between debt-equity choice and operating performance.

• Item Type: MPRA Paper
• Language: English
• Keywords: Debt-equity choice; Asymmetric information; Timing of earnings; Long-term underperformance
• Subjects: G - Financial Economics > G3 - Corporate Finance and Governance > G33 - Bankruptcy ; Liquidation; G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy ; Financial Risk and Risk Management ; Capital and Ownership Structure ; Value of Firms ; Goodwill; G - Financial Economics > G2 - Financial Institutions and Services > G24 - Investment Banking ; Venture Capital ; Brokerage ; Ratings and Ratings Agencies; D - Microeconomics > D9 - Intertemporal Choice > D92 - Intertemporal Firm Choice, Investment, Capacity, and Financing; D - Microeconomics > D8 - Information, Knowledge, and Uncertainty > D82 - Asymmetric and Private Information ; Mechanism Design; C - Mathematical and Quantitative Methods > C7 - Game Theory and Bargaining Theory > C73 - Stochastic and Dynamic Games ; Evolutionary Games ; Repeated Games

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