Lecture12 - 13 - agency moral hazard adverse selection

Dividends

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Unformatted text preview: ers know this and may choose a higher debt ratio than the one they would have chosen otherwise 33 Signaling With Debt Issuance of debt may signal positive news, while debt reduction may be a negative signal about the company. Studies regarding debt announcements and the signals they provide have shown that equity prices increase when firms issue debt and fall when firms retire debt Plausible, but can we come up with other explanations? Can also think of using debt to signal to competing firms: choosing high debt shows that you are financially sound, and this may discourage some action from competitors 34 Signaling With Equity A firm wants to raise money for a project issuing debt or equity If it issues new equity, it invites outsiders to become firm owners, and thus to share all of its existing assets. If it issues new debt, lenders get capital plus interest, but do not share the firm’s existing assets. Because of market imperfections, the market value of equity may differ from its true value. Managers know the equity’s true val...
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