Dynamic Investment and Financing under Asymmetric Information

Erwan Morellec and Norman Schurhoff
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Erwan Morellec: Ecole Polytechnique Federale de Lausanne (EPFL), Swiss Finance Institute and CEPR
Norman Schurhoff: University of Lausanne and Swiss Finance Institute
Authors registered in the RePEc Author Service: Norman Schuerhoff

No 09-09, Swiss Finance Institute Research Paper Series from Swiss Finance Institute

Abstract: This paper develops a tractable real options framework to analyze the effects of asymmetric information on investment and financing decisions when firms require external funds to finance investment. Our analysis shows that corporate insiders can signal their private information to outside investors using the timing of investment and the firm's debt-equity mix. Several important contributions follow from this result. First, we show that firms' equilibrium investment strategies differ significantly from those implied by standard real options models with perfect information. In particular, informational asymmetries erode the option value of waiting to invest and induce firms with good prospects to speed up investment, leading to overinvestment. Second, we demonstrate that informational asymmetries may not translate into a financing hierarchy. Most notably, we find that equity issues can be more attractive than debt issues even for firms with ample debt capacity, providing a rationale for the stylized fact that small high-growth firms do not behave according to the pecking order theory.

Keywords: asymmetric information; financing decisions; investment timing (search for similar items in EconPapers)
JEL-codes: G13 G14 G31 G34 (search for similar items in EconPapers)
Pages: 52 pages
Date: 2009-03
New Economics Papers: this item is included in nep-bec, nep-cfn and nep-cta
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Citations: View citations in EconPapers (2)

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Persistent link: https://EconPapers.repec.org/RePEc:chf:rpseri:rp0909

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