Asymmetric information, disagreement, and the valuation of debt and equity

Snehal Banerjee, Bradyn Breon-Drish and Kevin Smith

Journal of Financial Economics, 2025, vol. 165, issue C

Abstract: We study debt and equity valuation when investors have private information and may exhibit differences of opinion. Our model generates several predictions that are consistent with empirical evidence but difficult to reconcile with traditional models. Belief dispersion relates to expected equity and debt returns in opposite directions. Similarly, expected debt (equity) returns typically increase (decrease) with default risk, though these relationships reverse for firms close to bankruptcy. Firms’ capital structures affect their valuations even without classical capital structure frictions (e.g., tax shields, distress costs) – when liquidity is higher in the equity than in the debt market, leverage can raise firm value.

Keywords: Capital structure; Rational expectations; Difference of opinions; Disagreement; Liquidity trading; Information quality (search for similar items in EconPapers)
JEL-codes: G10 G12 G14 G32 (search for similar items in EconPapers)
Date: 2025
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Persistent link: https://EconPapers.repec.org/RePEc:eee:jfinec:v:165:y:2025:i:c:s0304405x25000030

DOI: 10.1016/j.jfineco.2025.103995

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