Optimal Issuance under Information Asymmetry and Accumulation of Cash Flows

Abstract

We study the optimal timing of security issuance to finance a new project when the firm's assets in place have unobservable quality. Stochastic cash flows generated by assets in place reveal information about their quality and simultaneously reduce the required outside funding. A high-quality firm optimally delays issuance unless its accumulated cash or the market belief about its quality is sufficiently high. A low-quality firm does the same and, additionally, issues if market belief and accumulated cash are sufficiently low. Under stated restrictions, the renegotiation-proof optimal security pays outside investors in full before paying anything to original shareholders.

Keywords: dynamic information asymmetry, financing, cash flow accumulation, issuance delay, optimal security

JEL Classification: G31, G32