Hostname: page-component-745bb68f8f-b6zl4 Total loading time: 0 Render date: 2025-01-12T01:55:09.523Z Has data issue: false hasContentIssue false
  • English
  • Français

Informational Efficiency and Liquidity Premium as the Determinants of Capital Structure

Published online by Cambridge University Press:  19 February 2010

Chun Chang  and
Xiaoyun Yu
Chun Chang
Affiliation:
China Europe International Business School, 699 Hongfeng Road, Pudong, Shanghai 201206, China. [email protected]
Xiaoyun Yu
Affiliation:
Kelley School of Business, Indiana University, 1309 E. 10th St., Bloomington, IN 47405. [email protected]
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper investigates how a firm’s capital structure choice affects the informational efficiency of its security prices in the secondary markets. We identify two new determinants of a firm’s capital structure policy: the liquidity (adverse selection) premium due to investors’ anticipated losses to informed trading, and operating efficiency improvement due to information revelation from the firm’s security prices. We show that the capital structure decision affects traders’ incentives to acquire information and subsequently, the distribution of informed traders across debt and equity claims. When information is less imperative for improving its operating decisions, a firm issues zero or negative debt (i.e., holding excess cash reserves) in order to reduce socially wasteful information acquisition and the liquidity premium associated with it. When information is crucial for a firm’s operating decisions, the optimal debt level is one that achieves maximum information revelation at the lowest possible liquidity cost. Our model can explain why many firms consistently hold no debt. It also provides new implications for financial system design and for the relationship among leverage, liquidity premium, profitability, and the cost of information acquisition.

Type
Research Articles
Information
Journal of Financial and Quantitative Analysis , Volume 45 , Issue 2 , April 2010 , pp. 401 - 440
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2010

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Admati, A. R., and Pfleiderer, P.. “A Theory of Intraday Patterns: Volume and Price Variability.” Review of Financial Studies, 1 (1988), 3–40.CrossRefGoogle Scholar
Allen, F. “Stock Markets and Resource Allocation.” In Capital Markets and Financial Intermediation, Mayer, C. and Vives, X., eds. Cambridge, UK: Cambridge University Press (1993).Google Scholar
Amihud, Y., and Mendelson, H.. “The Liquidity Route to a Lower Cost of Capital.” Journal of Applied Corporate Finance, 12 (2000), 8–25.CrossRefGoogle Scholar
Bakke, T.-E., and Whited, T. M.. “Which Firms Follow the Market? An Analysis of Corporate Investment Decisions.” Working Paper, University of Wisconsin, Madison (2006).CrossRefGoogle Scholar
Bhattacharya, U., and Daouk, H.. “The World Price of Insider Trading.” Journal of Finance, 57 (2002), 75–108.CrossRefGoogle Scholar
Boot, A. W. A., and Thakor, A. V.. “Security Design.” Journal of Finance, 48 (1993), 1349–1378.CrossRefGoogle Scholar
Boot, A. W. A., and Thakor, A. V.. “Financial System Architecture.” Review of Financial Studies, 10 (1997), 693–733.CrossRefGoogle Scholar
Brennan, M. J., and Subrahmanyam, A.. “Market Microstructure and Asset Pricing: On the Compensation for Illiquidity in Stock Returns.” Journal of Financial Economics, 41 (1996), 441–464.CrossRefGoogle Scholar
Chang, C., and Yu, X.. “Investment Opportunities, Liquidity Premium, and Conglomerate Mergers.” Journal of Business, 77 (2004), 45–74.CrossRefGoogle Scholar
Chen, Q.; Goldstein, I.; and Jiang, W.. “Price Informativeness and Investment Sensitivity to Stock Price.” Review of Financial Studies, 20 (2007), 619–650.CrossRefGoogle Scholar
Cornelli, F., and Goldreich, D.. “Bookbuilding: How Informative Is the Order Book?” Journal of Finance, 58 (2003), 1415–1443.CrossRefGoogle Scholar
Diamond, D. W., and Dybvig, P. H.. “Bank Runs, Deposit Insurance, and Liquidity.” Journal of Political Economy, 91 (1983), 401–419.CrossRefGoogle Scholar
Dow, J., and Gorton, G.. “Stock Market Efficiency and Economic Efficiency: Is There a Connection?” Journal of Finance, 52 (1997), 1087–1129.CrossRefGoogle Scholar
Durnev, A.; Morck, R.; and Yeung, B.. “Value-Enhancing Capital Budgeting and Firm-Specific Stock Return Variation.” Journal of Finance, 59 (2004), 65–105.CrossRefGoogle Scholar
Easley, D.; Hvidkjaer, S.; and O’Hara, M.. “Is Information Risk a Determinant of Asset Returns?” Journal of Finance, 57 (2002), 2185–2221.CrossRefGoogle Scholar
Easley, D., and O’Hara, M.. “Information and the Cost of Capital.” Journal of Finance, 59 (2004), 1553–1583.CrossRefGoogle Scholar
Fulghieri, P., and Lukin, D.. “Information Production, Dilution Costs, and Optimal Security Design.” Journal of Financial Economics, 61 (2001), 3–42.CrossRefGoogle Scholar
Giammarino, R.; Heinkel, R.; Hollifield, B.; and Li, K.. “Corporate Decisions, Information, and Prices: Do Managers Move Prices or Do Prices Move Managers?” Economic Notes, 33 (2004), 83–110.CrossRefGoogle Scholar
Gorton, G., and Pennacchi, G.. “Financial Intermediaries and Liquidity Creation.” Journal of Finance, 45 (1990), 49–71.CrossRefGoogle Scholar
Gorton, G. B., and Pennacchi, G. G.. “Security Baskets and Index-Linked Securities.” Journal of Business, 66 (1993), 1–28.CrossRefGoogle Scholar
Graham, J. R. “How Big Are the Tax Benefits of Debt?” Journal of Finance, 55 (2000), 1901–1941.CrossRefGoogle Scholar
Habib, M. A., and Johnsen, D. B.. “The Private Placement of Debt and Outside Equity as an Information Revelation Mechanism.” Review of Financial Studies, 13 (2000), 1017–1055.CrossRefGoogle Scholar
Hanley, K. W. “The Underpricing of Initial Public Offerings and the Partial Adjustment Phenomenon.” Journal of Financial Economics, 34 (1993), 231–250.CrossRefGoogle Scholar
Harris, M., and Raviv, A.. “The Theory of Capital Structure.” Journal of Finance, 46 (1991), 297–355.CrossRefGoogle Scholar
Haugen, R. A., and Senbet, L. W.. “Bankruptcy and Agency Costs: Their Significance to the Theory of Optimal Capital Structure.” Journal of Financial and Quantitative Analysis, 23 (1988), 27–38.CrossRefGoogle Scholar
Hayek, F. A. “The Use of Knowledge in Society.” American Economic Review, 35 (1945), 519–530.Google Scholar
Hirshleifer, J. “The Private and Social Value of Information and the Reward to Inventive Activity.” American Economic Review, 61 (1971), 561–573.Google Scholar
Holmström, B., and Tirole, J.. “Market Liquidity and Performance Monitoring.” Journal of Political Economy, 101 (1993), 678–709.CrossRefGoogle Scholar
Jensen, M. C. “Agency Costs of Free Cash Flow, Corporate Finance, and Takeovers.” American Economic Review, 76 (1986), 323–329.Google Scholar
Kyle, A. S. “Continuous Auctions and Insider Trading.” Econometrica, 53 (1985), 1315–1336.CrossRefGoogle Scholar
Lesmond, D.; O’Connor, P.; and Senbet, L.. “Capital Structure and Equity Liquidity.” Working Paper, Tulane University and University of Maryland (2008).CrossRefGoogle Scholar
Lipson, M. L., and Mortal, S.. “Liquidity and Capital Structure.” Journal of Financial Markets, 12 (2009), 611–644.CrossRefGoogle Scholar
Maug, E.. “Ownership Structure and the Life-Cycle of the Firm: A Theory of the Decision to Go Public.” European Finance Review, 5 (2001), 167–200.CrossRefGoogle Scholar
Mikkelson, W. H., and Partch, M. M.. “Do Persistent Large Cash Reserves Hinder Performance?” Journal of Financial and Quantitative Analysis, 38 (2003), 275–294.CrossRefGoogle Scholar
Miller, M. H. “Debt and Taxes.” Journal of Finance, 32 (1977), 261–275.Google Scholar
Morck, R.; Yeung, B.; and Yu, W.. “The Information Content of Stock Markets: Why Do Emerging Markets Have Synchronous Stock Price Movements?” Journal of Financial Economics, 58 (2000), 215–260.CrossRefGoogle Scholar
Myers, S. C. “Determinants of Corporate Borrowing.” Journal of Financial Economics, 5 (1977), 147–175.CrossRefGoogle Scholar
Myers, S. C. “Financing of Corporations.” In Handbook of the Economics of Finance, Vol. 1A, Corporate Finance, Constantinides, G., Harris, M. and Stulz, R. M., eds. Amsterdam: Elsevier BV (2003).Google Scholar
Opler, T.; Pinkowitz, L.; Stulz, R.; and Williamson, R.. “The Determinants and Implications of Corporate Cash Holdings.” Journal of Financial Economics, 52 (1999), 3–46.CrossRefGoogle Scholar
Rajan, R. G., and Zingales, L.. “Which Capitalism? Lessons from the East Asian Crisis.” Journal of Applied Corporate Finance, 11 (1998), 40–48.CrossRefGoogle Scholar
Strebulaev, I. A., and Yang, B.. “The Mystery of Zero-Leverage Firms.” Working Paper, Stanford University (2006).Google Scholar
Subrahmanyam, A.. “A Theory of Trading in Stock Index Futures.” Review of Financial Studies, 4 (1991), 17–51.CrossRefGoogle Scholar
Subrahmanyam, A., and Titman, S.. “The Going-Public Decision and the Development of Financial Markets.” Journal of Finance, 54 (1999), 1045–1082.CrossRefGoogle Scholar
Wurgler, J. “Financial Markets and the Allocation of Capital.” Journal of Financial Economics, 58 (2000), 187–214.CrossRefGoogle Scholar