Asymmetric Information and Signaling in Finance

It implies that management's decisions are aimed at maximizing the intrinsic value for existing shareholders, rather than pursuing personal gain.

Intrinsic value represents the true worth of the assets to the company, while market value can differ due to investor perceptions and lack of information.

The firm may avoid such projects due to the risk of issuing new equity, which could lead to diluting existing shareholders' value.

<p>It suggests that firms prefer internal financing first, then debt, and finally equity, reflecting a desire to avoid the costs associated with external financing.</p> Signup and view all the answers

<p>Passive old shareholders might lead to suboptimal decisions by not actively participating in or influencing investment opportunities.</p> Signup and view all the answers

<p>Internal financing is preferred, followed by debt, and then equity.</p> Signup and view all the answers

<p>The model assumes a perfect capital market, meaning no taxes, transaction costs, or other imperfections.</p> Signup and view all the answers

<p>If the firm's cash and marketable securities (S) are less than the required investment (I), it needs to seek new equity.</p> Signup and view all the answers

<p>To raise part or all of the necessary cash required for the investment project.</p> Signup and view all the answers

<p>Ā represents the value of asset-in-place, while B̄ represents the net present value (NPV) of the project.</p> Signup and view all the answers

<p>Asymmetric information suggests that managers possess more knowledge about the firm's assets and opportunities than outside investors.</p> Signup and view all the answers

<p>The manager has unique insights into the value of the asset and the expected NPV of the project.</p> Signup and view all the answers

<p>It refers to the preference of firms to finance new projects first with internal funds, then with debt, and lastly with equity.</p> Signup and view all the answers

<p>The manager should prioritize using internal funds, then debt, and ideally avoid issuing equity due to potential signaling issues.</p> Signup and view all the answers

<p>With a risk-free interest rate of zero, the cost of debt is effectively minimized, making it more attractive compared to equity.</p> Signup and view all the answers

<p>The valuable real investment opportunity can expire or be lost, potentially harming the firm's growth prospects.</p> Signup and view all the answers

<p>Financial slack refers to the available cash and marketable securities that a firm has at its disposal.</p> Signup and view all the answers

<p>Firms with access to valuable investment opportunities face financing challenges due to their better-informed managers.</p> Signup and view all the answers

<p>If the firm delays launching the project, the opportunity may evaporate, leading to potential losses.</p> Signup and view all the answers

<p>Firms were advised to evaluate projects assuming they had plenty of cash available to pursue positive NPV projects.</p> Signup and view all the answers

<p>Because these projects can create value for the firm and its shareholders if funded appropriately and on time.</p> Signup and view all the answers

<p>Slack allows a firm to invest without needing to issue equity, thus avoiding potential negative signals to investors.</p> Signup and view all the answers

<p>A firm should issue stock when the value if not issued is less than or equal to the value if issued, specifically when $V_{old} ext{ (S + a)} eq ext{ }(S + a + E + b)$.</p> Signup and view all the answers

<p>It signifies that old shareholders will support equity issuance if the project payoff is sufficiently high compared to giving up asset payoffs.</p> Signup and view all the answers

<p>The firm should operate in the M-region if it decides not to issue equity and invest.</p> Signup and view all the answers

<p>If investors are aware that the firm doesn't need to issue equity, any attempt to do so sends a strong pessimistic signal, potentially affecting stock value.</p> Signup and view all the answers

<p>Old shareholders must give up some asset payoff to potentially gain from the new project's payoff when equity is issued.</p> Signup and view all the answers

<p>A low value of 'a' represents giving up little from existing assets, while a high value of 'b' indicates a substantial benefit from investing in new projects.</p> Signup and view all the answers

<p>Issuing equity when it is overvalued allows the firm to take advantage of investor perceptions without triggering negative signals.</p> Signup and view all the answers

<p>It implies that more NPV &gt; 0 projects are undertaken with debt financing, leading to less underinvestment.</p> Signup and view all the answers

<p>A manager should issue debt when the condition b − ∆D ≧ 0 holds true.</p> Signup and view all the answers

<p>It signals that b − ∆E &gt; b − ∆D, indicating that ∆E &lt; ∆D.</p> Signup and view all the answers

<p>Firms prefer internal financing to avoid the costs and risks associated with external financing.</p> Signup and view all the answers

<p>It implies that equity is more responsive to information revelations than debt.</p> Signup and view all the answers

<p>There does not exist an equilibrium price PE′ where new equity is preferred over debt, as investors are unwilling to buy equity.</p> Signup and view all the answers

<p>Firms prefer to issue bonds when external financing is necessary, especially if there are concerns about potential capital loss from equity.</p> Signup and view all the answers

<p>The theory suggests that firms never issue new equity due to adverse signals it sends to the market.</p> Signup and view all the answers

<p>P' depends on the joint density of (Ã, B̃) and the regions M' and M.</p> Signup and view all the answers

<p>The problem disappears, and the firm will always undertake NPV &gt; 0 projects.</p> Signup and view all the answers

<p>The policy is strictly obeyed, meaning it dictates the firm's financing behavior throughout the investment process.</p> Signup and view all the answers

<p>It is represented as ∆E, which affects the market value of new shares at t = 1.</p> Signup and view all the answers

<p>Old shareholders will invest iff S + a ≤ S + a + b − (E1 − E), which simplifies to ∆E ≤ b.</p> Signup and view all the answers

<p>∆D represents the capital gain to debt holders at t = 1.</p> Signup and view all the answers

<p>It indicates that the firm is mindful of the capital gain to debt holders and only invests if the gain does not exceed b.</p> Signup and view all the answers

<p>If debt is default-risk-free, then ∆D = 0, resulting in an effect similar to having more slack.</p> Signup and view all the answers

<p>It is assumed that sgn(∆E) = sgn(∆D) and |∆E| &gt; |∆D|.</p> Signup and view all the answers

<p>If ∆E, ∆D &gt; 0, it indicates that capital gains for both equity and debt holders are positive, influencing investment decisions.</p> Signup and view all the answers