A Robustness Check on Debt and the Pecking Order Hypothesis with Asymmetric Information

George Chang

International Journal of Economics and Finance, 2016, vol. 8, issue 6, 181

Abstract: Daniel and Titman (1995) examined the incentives of firms to signal their values prior to making a new equity offering. By analyzing this issue within a simple framework that encompasses a number of models in the literature, they were able to judge the relative efficiency of various signals that have been proposed. Although their analyses offer valuable insights, the robustness of their model has yet to be checked. This paper examines the parametric assumptions of their model in the section on debt and the pecking order hypothesis. We first generalize the assumptions in the example by Daniel and Titman (1995) to allow for continuous-state of nature. We then derive the resulting closed-form solution for the equilibrium payoffs to the original shareholders of both types firms under different beliefs. Although we only examine the robustness of a particular setting, our methodology can be applied to other settings.

Date: 2016
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