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Information Asymmetry Reduction in Opaque Contexts: Evidence From Debt and Outside Equity Financing in Early Stage Firms

Mircea Epure () and Martí Guasch

No 941, Working Papers from Barcelona Graduate School of Economics

Abstract: This study analyzes the relationship between debt and outside equity investments in early stage firms. The existing evidence on this relationship is scarce and inconclusive, mostly due to the pervasive opaqueness of early stage firms. We argue that outside investors who face the severe information asymmetries that exist in entrepreneurial firms may use the level of debt as a signal. In addition, personal and business debt could signal different information to outside investors. We use the Kauffman Firm Survey and develop an empirical strategy based on a Heckman selection model and a propensity score matching analysis. Our results consistently show that debt, and particularly business debt, is positively related to outside equity investments, especially in times of economic distress. We posit that start-ups with higher levels of business debt can send more credible signals to capital markets, and identify cash holdings and the firm-bank relationship as possible information channels for outside investors.

Keywords: financing; debt; equity; entrepreneurship; information asymmetry; capital structure (search for similar items in EconPapers)
JEL-codes: G32 M13 M40 (search for similar items in EconPapers)
New Economics Papers: this item is included in nep-bec, nep-cfn, nep-ent and nep-sbm
Date: 2016-11
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Working Paper: Information asymmetry reduction in opaque contexts: Evidence from debt and outside equity financing in early stage firms (2017) Downloads
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