Hostname: page-component-6bf8c574d5-pdxrj Total loading time: 0 Render date: 2025-03-04T00:54:18.110Z Has data issue: false hasContentIssue false
  • English
  • Français

Capital Structure with Information about the Upside and the Downside

Published online by Cambridge University Press:  25 October 2023

Pierre Chaigneau Open the ORCID record for Pierre Chaigneau [Opens in a new window]
Pierre Chaigneau*
Affiliation:
Queen’s University Smith School of Business
*
pierre.chaigneau@queensu.ca
Rights & Permissions [Opens in a new window]

Abstract

Core share and HTML view are not available for this content. However, as you have access to this content, a full PDF is available via the ‘Save PDF’ action button.

I introduce two dimensions of uncertainty, about the upside and the downside of an asset, in a model of asset valuation under asymmetric information. This justifies capital structures with equity and risky debt for information revelation purposes. However, a capital structure with only one information-sensitive security, equity, can be optimal when investors are less informed about the dimension that matters more for valuation. This is relevant for innovative firms with a large upside subject to strong information asymmetries, which often have abnormally low leverage, and for firms at an intermediate stage of their life cycle that do not issue risky debt.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 59 , Issue 8 , December 2024 , pp. 3921 - 3958
Creative Commons
Creative Common License - CCCreative Common License - BY
This is an Open Access article, distributed under the terms of the Creative Commons Attribution licence (http://creativecommons.org/licenses/by/4.0), which permits unrestricted re-use, distribution and reproduction, provided the original article is properly cited.
Copyright
© The Author(s), 2023. Published by Cambridge University Press on behalf of the Michael G. Foster School of Business, University of Washington

Footnotes

I thank Hendrik Bessembinder (the editor), Itay Goldstein, Dirk Hackbarth (the referee), and Liyan Yang for enlightening discussions about this project.

References

Allen, F., and Barbalau, A.. “Security Design: A Review.” Working Paper, Imperial College London (2022).CrossRefGoogle Scholar
Allen, F., and Gale, D.. “Optimal Security Design.” Review of Financial Studies, 1 (1988), 229–263.CrossRefGoogle Scholar
Asriyan, V., and Vanasco, V.. “Security Design in Non-Exclusive Markets with Asymmetric Information.” Review of Economic Studies, 90 (2023), 2674.Google Scholar
Axelson, U. “Pooling, Splitting, and Security Design in the Auctioning of Financial Assets.” Working Paper, Carnegie Mellon University (1999).Google Scholar
Axelson, U. “Security Design with Investor Private Information.” Journal of Finance, 62 (2007), 2587–2632.CrossRefGoogle Scholar
Berger, A. N., and Udell, G. F.. “The Economics of Small Business Finance: The Roles of Private Equity and Debt Markets in the Financial Growth Cycle.” Journal of Banking & Finance, 22 (1998), 613–673.CrossRefGoogle Scholar
Bertomeu, J.; Beyer, A.; and Dye, R. A.. “Capital Structure, Cost of Capital, and Voluntary Disclosures.” Accounting Review, 86 (2011), 857–886.CrossRefGoogle Scholar
Bessembinder, H.; Hao, J.; and Zheng, K.. “Market Making Contracts, Firm Value, and the IPO Decision.” Journal of Finance, 70 (2015), 1997–2028.CrossRefGoogle Scholar
Biais, B., and Casamatta, C.. “Optimal Leverage and Aggregate Investment.” Journal of Finance, 54 (1999), 1291–1323.CrossRefGoogle Scholar
Boot, A. W., and Thakor, A. V.. “Security Design.” Journal of Finance, 48 (1993), 1349–1378.CrossRefGoogle Scholar
Cefis, E., and Ciccarelli, M.. “Profit Differentials and Innovation.” Economics of Innovation and New Technology, 14 (2005), 43–61.CrossRefGoogle Scholar
Chang, C., and Yu, X.. “Informational Efficiency and Liquidity Premium as the Determinants of Capital Structure.” Journal of Financial and Quantitative Analysis, 45 (2010), 401–440.CrossRefGoogle Scholar
Dangl, T., and Zechner, J.. “Debt Maturity and the Dynamics of Leverage.” Review of Financial Studies, 34 (2021), 5796–5840.CrossRefGoogle Scholar
Danis, A.; Rettl, D. A.; and Whited, T. M.. “Refinancing, Profitability, and Capital Structure.” Journal of Financial Economics, 114 (2014), 424–443.CrossRefGoogle Scholar
DeAngelo, H.; Gonçalves’, A. S. and Stulz, R. M.. “Corporate Deleveraging and Financial Flexibility.” Review of Financial Studies, 31 (2018), 3122–3174.CrossRefGoogle Scholar
DeMarzo, P. M. “The Pooling and Tranching of Securities: A Model of Informed Intermediation.” Review of Financial Studies, 18 (2005), 1–35.CrossRefGoogle Scholar
DeMarzo, P. M., and Duffie, D.. “A Liquidity-Based Model of Security Design.” Econometrica, 67 (1999), 65–99.CrossRefGoogle Scholar
DeMarzo, P. M.; Frankel, D. M.; and Jin, Y.. “Portfolio Liquidity and Security Design with Private Information.” Review of Financial Studies, 34 (2021), 5841–5885.CrossRefGoogle Scholar
Diamond, D. W., and Dybvig, P. H.. “Bank Runs, Deposit Insurance, and Liquidity.” Journal of Political Economy, 91 (1983), 401–419.CrossRefGoogle Scholar
Dinlersoz, E. M.; Hyatt, H.; Kalemli-Ozcan, S.; and Penciakova, V.. “Leverage over the Firm Life Cycle, Firm Growth, and Aggregate Fluctuations.” Working Paper, Federal Reserve Bank of Atlanta (2019).CrossRefGoogle Scholar
Dow, J., and Gorton, G.. “Noise Trading, Delegated Portfolio Management, and Economic Welfare.” Journal of Political Economy, 105 (1997), 1024–1050.CrossRefGoogle Scholar
Eckbo, B. E., and Kisser, M.. “The Leverage-Profitability Puzzle Resurrected.” Review of Finance, 25 (2021), 1089–1128.CrossRefGoogle Scholar
Fluck, Z.; Holtz-Eakin, D.; and Rosen, H. S.. “Where Does the Money Come From? The Financing of Small Entrepreneurial Enterprises.” Working Paper, New York University (1997).Google Scholar
Frank, M. Z., and Goyal, V. K.. “Capital Structure Decisions: Which Factors Are Reliably Important?” Financial Management, 38 (2009), 1–37.CrossRefGoogle Scholar
Fulghieri, P.; García, D.; and Hackbarth, D.. “Asymmetric Information and the Pecking (Dis)Order.” Review of Finance, 24 (2020), 961–996.CrossRefGoogle Scholar
Fulghieri, P., and Lukin, D.. “Information Production, Dilution Costs, and Optimal Security Design.” Journal of Financial Economics, 61 (2001), 3–42.CrossRefGoogle Scholar
Garmaise, M. J. “Rational Beliefs and Security Design.” Review of Financial Studies, 14 (2001), 1183–1213.CrossRefGoogle Scholar
Geroski, P.; Machin, S.; and Van Reenen, J.. “The Profitability of Innovating Firms.” RAND Journal of Economics, 24 (1993), 198–211.CrossRefGoogle Scholar
Glasserman, P., and Mamaysky, H.. “Investor Information Choice with Macro and Micro Information.” Review of Asset Pricing Studies, 13 (2023), 1–52.CrossRefGoogle Scholar
Goldstein, R.; Ju, N.; and Leland, H.. “An EBIT-Based Model of Dynamic Capital Structure.” Journal of Business, 74 (2001), 483–512.CrossRefGoogle Scholar
Goldstein, I., and Yang, L.. “Information Diversity and Complementarities in Trading and Information Acquisition.” Journal of Finance, 70 (2015), 1723–1765.CrossRefGoogle Scholar
Goldstein, I., and Yang, L.. “Good Disclosure, Bad Disclosure.” Journal of Financial Economics, 131 (2019), 118–138.CrossRefGoogle Scholar
Gorton, G., and Pennacchi, G.. “Financial Intermediaries and Liquidity Creation.” Journal of Finance, 45 (1990), 49–71.CrossRefGoogle Scholar
Healy, P. M., and Palepu, K. G.. “Information Asymmetry, Corporate Disclosure, and the Capital Markets: A Review of the Empirical Disclosure Literature.” Journal of Accounting and Economics, 31 (2001), 405–440.CrossRefGoogle Scholar
Hébert, B. “Moral Hazard and the Optimality of Debt.” Review of Economic Studies, 85 (2018), 2214–2252.CrossRefGoogle Scholar
Hovakimian, A.; Opler, T.; and Titman, S.. “The Debt-Equity Choice.” Journal of Financial and Quantitative Analysis, 36 (2001), 1–24.CrossRefGoogle Scholar
Inostroza, N., and Tsoy, A.. “Optimal Information and Security Design.” Working Paper, University of Toronto (2023).CrossRefGoogle Scholar
John, T. A., and John, K.. “Top-Management Compensation and Capital Structure.” Journal of Finance, 48 (1993), 949–974.Google Scholar
John, K.; Saunders, A.; and Senbet, L. W.. “A Theory of Bank Regulation and Management Compensation.” Review of Financial Studies, 13 (2000), 95–125.CrossRefGoogle Scholar
Kacperczyk, M.; Van Nieuwerburgh, S.; and Veldkamp, L.. “A Rational Theory of Mutual Funds’ Attention Allocation.” Econometrica, 84 (2016), 571–626.CrossRefGoogle Scholar
Machado, C., and Pereira, A. E.. “Optimal Capital Structure with Stock Market Feedback.” Review of Finance, 27 (2023), 1329–1371.CrossRefGoogle Scholar
Maćkowiak, B.; Matĕjka, F.; and Wiederholt, M.. “Rational Inattention: A Review.” Journal of Economic Literature, 61 (2023), 226–273.CrossRefGoogle Scholar
Malenko, A., and Tsoy, A.. “Asymmetric Information and Security Design Under Knightian Uncertainty.” Working Paper, Boston College (2020).Google Scholar
Myers, S. C. “Still Searching for Optimal Capital Structure.” Journal of Applied Corporate Finance, 1 (1993), 4–14.CrossRefGoogle Scholar
Myers, S. C., and Majluf, N. S.. “Corporate Financing and Investment Decisions when Firms Have Information that Investors Do Not Have.” Journal of Financial Economics, 13 (1984), 187–221.CrossRefGoogle Scholar
Nachman, D. C.; and Noe, T. H.. “Optimal Design of Securities Under Asymmetric Information.” Review of Financial Studies, 7 (1994), 1–44.CrossRefGoogle Scholar
Paul, J. M. “Crowding Out and the Informativeness of Security Prices.” Journal of Finance, 48 (1993), 1475–1496.CrossRefGoogle Scholar
Rajan, R. G., and Zingales, L.. “What Do We Know About Capital Structure? Some Evidence from International Data.” Journal of Finance, 50 (1995), 1421–1460.CrossRefGoogle Scholar
Smith, K. “Financial Markets with Trade on Risk and Return.” Review of Financial Studies, 32 (2019), 4042–4078.CrossRefGoogle Scholar
Strebulaev, I.A., and Yang, B.. “The Mystery of Zero-Leverage Firms.” Journal of Financial Economics, 109 (2013), 1–23.CrossRefGoogle Scholar
Subrahmanyam, A. “A Theory of Trading in Stock Index Futures.” Review of Financial Studies, 4 (1991), 17–51.CrossRefGoogle Scholar
Van Nieuwerburgh, S., and Veldkamp, L.. “Information Acquisition and Under-Diversification.” Review of Economic Studies, 77 (2010), 779–805.CrossRefGoogle Scholar
Yang, M. “Optimality of Debt Under Flexible Information Acquisition.” Review of Economic Studies, 87 (2020), 487–536.CrossRefGoogle Scholar
Yang, M., and Zeng, Y.. “Financing Entrepreneurial Production: Security Design with Flexible Information Acquisition.” Review of Financial Studies, 32 (2019), 819–863.CrossRefGoogle Scholar
Supplementary material: PDF

Chaigneau supplementary material

Chaigneau supplementary material

Download Chaigneau supplementary material(PDF)
PDF 4.6 MB