fm16 17 - MM assumed that investors and managers have the...

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Mini Case: 16 - 17 MM assumed that investors and managers have the same information. But managers often have better information. Thus, they would sell stock if stock is overvalued, and sell bonds if stock is undervalued. Investors understand this, so view new stock sales as a negative signal. This is signaling theory. The pecking order theory states that Firms use internally generated funds first, because there are no flotation costs or negative signals. If more funds are needed, firms then issue debt because it has lower flotation costs than equity and not negative signals. If more funds are needed, firms then issue equity. One agency problem is that managers can use corporate funds for non-value maximizing purposes. The use of financial leverage bonds “free cash flow,” and forces discipline on managers to avoid perks and non-value adding acquisitions. A second agency problem is the potential for “underinvestment”. Debt increases risk of financial distress. Therefore, managers may avoid risky projects even if they have
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This note was uploaded on 07/13/2011 for the course FIN 4414 taught by Professor Staff during the Spring '08 term at University of Florida.

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