Asymmetric Information and the Pecking (Dis)Order

42 Pages Posted: 20 Mar 2012 Last revised: 26 Jan 2020

See all articles by Paolo Fulghieri

Paolo Fulghieri

University of North Carolina Kenan-Flagler Business School; European Corporate Governance Institute (ECGI)

Diego Garcia

University of Colorado at Boulder - Leeds School of Business

Dirk Hackbarth

Boston University - Department of Finance & Economics; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Date Written: January 23, 2020

Abstract

We study the classical problem of raising capital under asymmetric information. Following Myers and Majluf (1984), we consider firms endowed with assets in place and riskier growth opportunities. When asymmetric information is concentrated on assets in place (rather than growth opportunities), equity-like securities are more likely to be optimal. In contrast, when asymmetric information falls on growth options, debt is optimal. Intuitively, this happens because when the asset with greater volatility is less affected by asymmetric information, issuing a security with greater exposure to upside potential (such as equity) can be less dilutive than issuing a security lacking such exposure (such as debt). Our results suggest that equity is more likely to dominate debt for younger firms with larger investment needs, endowed with riskier, more valuable growth opportunities. Thus, our model can explain why high-growth firms may prefer equity over debt, and then switch to debt financing as they mature.

Keywords: debt-equity choice, pecking order, asymmetric information, security design

JEL Classification: G32

Suggested Citation

Fulghieri, Paolo and Garcia, Diego and Hackbarth, Dirk, Asymmetric Information and the Pecking (Dis)Order (January 23, 2020). UNC Kenan-Flagler Research Paper No. 2012-6. Available at SSRN: https://ssrn.com/abstract=2024666 or http://dx.doi.org/10.2139/ssrn.2024666

Paolo Fulghieri

University of North Carolina Kenan-Flagler Business School ( email )

Kenan-Flagler Business School
Chapel Hill, NC 27599-3490
United States

European Corporate Governance Institute (ECGI)

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

HOME PAGE: http://www.ecgi.org

Diego Garcia (Contact Author)

University of Colorado at Boulder - Leeds School of Business ( email )

Boulder, CO 80309-0419
United States

Dirk Hackbarth

Boston University - Department of Finance & Economics ( email )

Department of Finance
595 Commonwealth Avenue
Boston, MA 02215
United States
(617) 358-4206 (Phone)
(617) 353-6667 (Fax)

HOME PAGE: http://people.bu.edu/dhackbar/

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o the Royal Academies of Belgium
Rue Ducale 1 Hertogsstraat
1000 Brussels
Belgium

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