Agency Costs of Equity
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Questions and Answers

What does the Pecking Order Theory suggest regarding firms' capital structure?

  • Firms should aim for an optimal capital structure.
  • Firms should rely on debt financing only.
  • Firms should always select the financing option with the lowest cost. (correct)
  • Firms should prioritize equity financing regardless of cost.

    • What are adverse selection costs primarily caused by in the context of financing?

  • Growth opportunities
  • Inflation rates
  • Information asymmetry (correct)
  • High interest rates

    • What does information asymmetry refer to in the context of the Pecking Order Theory?

  • Perfect knowledge of all parties involved
  • No access to relevant information by any party
  • An equal distribution of information among all stakeholders
  • A situation where only the seller has more information than the buyer (correct)

    • How can a seller potentially take advantage in a situation of information asymmetry?

    <p>By deceiving buyers about the quality of goods</p> Signup and view all the answers

    What could be a consequence if a seller is willing to accept a low price for high-quality items?

    <p>The seller may face adverse selection issues</p> Signup and view all the answers

    In the context of financing, what might happen if a firm aims for an optimal capital structure ignoring costs?

    <p>The firm might face financial distress</p> Signup and view all the answers

    How can adverse selection impact firms' financing decisions according to the Pecking Order Theory?

    <p>By encouraging firms to prioritize equity over debt financing</p> Signup and view all the answers

    What is one potential consequence of information asymmetry in a market transaction?

    <p>Decreased market efficiency</p> Signup and view all the answers

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