Asymmetric Information, Debt Capacity, and Capital Structure

Michael L. Lemmon and Jaime F. Zender

Journal of Financial and Quantitative Analysis, 2019, vol. 54, issue 1, 31-59

Abstract: Capital structure choice based on costs associated with asymmetric information is examined in order to present a new perspective on the standard pecking order and trade-off theories. In the model, both the face value of debt and the restrictiveness of the associated debt covenants are chosen as part of the financial structure, allowing a more complete characterization of this decision. Debt structure choice balances ex ante adverse selection against ex post moral hazard, providing a natural integration of the pecking order and trade-off theories and the development of interesting empirical implications.

Date: 2019
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