Security Choice and the Announcement Effect
29 Pages Posted: 3 Nov 2015 Last revised: 4 Oct 2018
Date Written: April 11, 2018
This paper analyzes the choice between debt and equity under ex-ante asymmetric information and zero bankruptcy costs and how this choice depends on the relative announcement effects for debt and equity offerings. A novel implication of the model is that firms prefer the security with the least negative announcement effect, which may be debt or equity depending on parameter values. Nonetheless, the model implies that, in equilibrium, debt offerings will be associated with less negative (to zero) announcement returns compared to equity offerings. Finally, the model predicts riskier (less risky) investment opportunities to be financed with equity (debt).
Keywords: Capital raising, Asymmetric Information, Announcement Returns, Debt, Equity, Undervinvestment
JEL Classification: G30, G32
Suggested Citation: Suggested Citation