Information Risk and Capital Structure

54 Pages Posted: 25 Oct 2006 Last revised: 13 Nov 2007

See all articles by Prasun Agarwal

Prasun Agarwal

Cornell University - Johnson Graduate School of Management

Maureen O'Hara

Cornell University - Samuel Curtis Johnson Graduate School of Management

Date Written: March 2007

Abstract

In this paper, we investigate the effects of information asymmetry across equity investor groups as an explanation for the capital structure decisions of the firm. We test empirically whether differences in information across outside investors have any bearing on the leverage ratios of firms and on their choice of financing instrument when raising external capital. We use the probability of information-based trading (PIN) estimated using trade based data to test our theory. We find that firms with higher information risk (extrinsic information asymmetry across groups of investors) measured using PIN have higher market leverage. Extrinsic information asymmetry also seems to play a significant role in the firm's decision to issue debt or equity when raising capital, with high PIN firms more likely to issue debt. Comparing firms that issued debt and repurchased equity in the same year (increased leverage) with those that issued equity and repurchased debt in the same year (decreased leverage), we find firms with higher extrinsic information asymmetry are more likely to increase their leverage. These results strongly support the hypothesis that information risk affects capital structure after controlling for information asymmetry between firm managers and outside investors.

Keywords: Capital Structure, Information Asymmetry, Market Microstructure, Information Risk

JEL Classification: G10, G12, G14, G30, G32, D82

Suggested Citation

Agarwal, Prasun and O'Hara, Maureen, Information Risk and Capital Structure (March 2007). Available at SSRN: https://ssrn.com/abstract=939663 or http://dx.doi.org/10.2139/ssrn.939663

Prasun Agarwal (Contact Author)

Cornell University - Johnson Graduate School of Management ( email )

Ithaca, NY 14853-6201
United States

Maureen O'Hara

Cornell University - Samuel Curtis Johnson Graduate School of Management ( email )

Ithaca, NY 14853
United States
607-255-3645 (Phone)
607-255-5993 (Fax)

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