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Asymmetric Information, Signaling, and Optimal Corporate Financial Decisions

Published online by Cambridge University Press:  06 April 2009

Eli Talmor
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Extract

As is shown in the financial literature, the assumption of perfect and costless information often leads to the conclusion that corporate financial decisions are inconsequential to the value of the firm (e.g., Stiglitz [20] and Fama [6]). This conclusion seems to be in direct contradiction with the observed behavior of corporations that allocate real resources to implement financial policies. The gap between theory and observed behavior is bridged by introducing various frictions and market imperfections. A growing number of studies examine the optiraality of financial decisions when the assumption of perfect and costless information is replaced by allowing for informational asymmetry. The asymmetry is assumed to exist between corporate insiders who possess superior information about the firm's future earnings prospects and outside investors. The emphasis in this literature is on the ability of financial instruments to serve as signaling devices through which the true value of the firm can be revealed to the market without moral hazard or disclosure of confidential information. Although the signaling process is typically considered to be costly, it is advocated that firms may be better off if they employ this mechanism rather than reveal reliable, but confidential information, or not disclose at all.

Type
Financial Theory
Information
Journal of Financial and Quantitative Analysis , Volume 16 , Issue 4 , November 1981 , pp. 413 - 435
Copyright
Copyright © School of Business Administration, University of Washington 1981

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References

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