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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
*
[email protected]
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Abstract

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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.

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