Asymmetric information the situation in which

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Unformatted text preview: ons and future prospects than do investors. Two surveys examined capital structure decisions.12 Financial executives were asked which of two major criteria determined their financing decisions: (1) maintaining a target capital structure or (2) following a hierarchy of financing. This hierarchy, called a pecking order, begins with retained earnings, which is followed by debt financing and finally external equity financing. Respondents from 31 percent of Fortune 500 firms and from 11 percent of the (smaller) 500 largest overthe-counter firms answered target capital structure. Respondents from 69 percent of the Fortune 500 firms and 89 percent of the 500 largest OTC firms chose the pecking order. At first glance, on the basis of financial theory, this choice appears to be inconsistent with wealth maximization goals, but Stewart Myers has explained how “asymmetric information” could account for the pecking order financing preferences of financial managers.13 Asymmetric information results when managers of a firm have more information about operations...
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