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Capital Structure, Risk and Asymmetric Information

Quarterly Journal of Finance, Vol 1 (4), 767-809 (2011)

57 Pages Posted: 21 Jul 2004 Last revised: 25 Jul 2012

Nikolay Halov

New York University - Stern School of Business

Florian Heider

European Central Bank (ECB); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 3 versions of this paper

Date Written: November 1, 2011

Abstract

This paper argues that firms may not issue debt in order to avoid the adverse selection cost of debt. Theory suggests that since debt is a concave claim, it may be mispriced when outside investors are uninformed about firms’ risk. The empirical literature has however paid little attention the caveat that the “lemons” problem of external financing first identified by Myers (1984) only leads to debt issuance, i.e. a pecking order, if debt is risk free or, if it is risky, that it is not mispriced. This paper examines whether and for what firms the adverse selection cost of debt is more than a theoretical possibility and how this cost relates to other costs of debt such as bankruptcy. Absent any direct measure of something that is unknown to investors and thus cannot be in the econometrician’s information set, we present extensive strong and robust evidence in a large unbalanced panel of publicly traded US firms from 1971 to 2001 that firms avoid issuing debt when the outside market is likely to know little about their risk.

Keywords: capital structure, risk, asymmetric information, pecking-order hypothesis, adverse selection

JEL Classification: G32

Suggested Citation

Halov, Nikolay and Heider, Florian, Capital Structure, Risk and Asymmetric Information (November 1, 2011). Quarterly Journal of Finance, Vol 1 (4), 767-809 (2011). Available at SSRN: https://ssrn.com/abstract=566443 or http://dx.doi.org/10.2139/ssrn.566443

Nikolay Halov

New York University - Stern School of Business ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States

Florian Heider (Contact Author)

European Central Bank (ECB) ( email )

Sonnemannstrasse 22
Frankfurt am Main, 60314
Germany

HOME PAGE: http://https://sites.google.com/site/florianheider2/

Centre for Economic Policy Research (CEPR) ( email )

77 Bastwick Street
London, EC1V 3PZ
United Kingdom

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