Signalling with debt and equity: a unifying approach and its implications for the pecking order hypothesis and competitive credit rationing

Florian Heider

LSE Research Online Documents on Economics from London School of Economics and Political Science, LSE Library

Abstract: The paper sets out to tackle the following puzzle when insiders of a firm have more information than outside investors. The insiders' desire to sell overpriced securities creates an Adverse Selection problem leading to two contradictory results. On the one hand, it leads to Myers & Majluf (1984)'s Pecking-Order hypothesis that says that debt finance dominates equity finance. On the other hand it leads to Stiglitz & Weiss (1981)'s credit rationing whose consequence is that equity finance dominates debt finance. The paper resolves the puzzle by allowing firms to issue both debt and equity together and by having a general notion of what it is that insiders know more about. Then the Pecking-Order hypothesis and credit rationing only emerge as two, mutually exclusive, special cases. The paper shows that combinations of debt and equity can be used to credibly signal information for a wide range of parameters. Thus, it provides a generalisation of the existing financial signalling and rationing literatures and helps to explain some contradictory theoretical and empirical results.

JEL-codes: D82 G32 (search for similar items in EconPapers)
Pages: 31 pages
Date: 2001-07-01
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Citations: View citations in EconPapers (1)

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http://eprints.lse.ac.uk/25063/ Open access version. (application/pdf)

Related works:
Working Paper: Signalling with Debt and Equity: A Unifying Approach and its Implications for the Pecking Order Hypothesis and Competitive Credit Rationing (2001)
Working Paper: Signalling with debt and equity: a unifying approach and its implications for the Pecking-Order hypothesis and competitive credit rationing (2000)
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Persistent link: https://EconPapers.repec.org/RePEc:ehl:lserod:25063

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