13 asymmetric information results when managers of a

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Unformatted text preview: and future prospects than do investors. Assuming that managers make decisions with the goal of maximizing the wealth of existing stockholders, then asymmetric information can affect the capital structure decisions that managers make. Suppose, for example, that management has found a valuable investment that will require additional financing. Management believes that the prospects for the firm’s future are very good and that the market, as indicated by the firm’s current stock price, does not fully appreciate the firm’s value. In this case, it would be advantageous to current stockholders if management raised the required funds using debt rather than issuing new stock. Using debt to raise funds is frequently 12. The results of the survey of Fortune 500 firms are reported in J. Michael Pinegar and Lisa Wilbricht, “What Managers Think of Capital Structure Theory: A Survey,” Financial Management (Winter 1989), pp. 82–91, and the results of a similar survey of the 500 largest OTC firms are repo...
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