L5: Issuing securities and Informational Frictions Flashcards
Strong form efficiency
All information (private and public is incorporated in the prices)
Why does strong form efficiency seem odd?
Most convincing explanation of stock market reaction to security issues
Pooling equilibrium
More general proof
Why do firms have a pecking order of financing?
(the model before proofed this)
- If the firm had retained earnings the ENT wouldn’t need to issue either debt or equity, so he wouldn’t face any underpricing
- Underpricing of securities would be less with debt than with equity —> which is why external debt is prefered over external equity
Separating equilibrium
Main lessons
Senior debt
Money owed by a company that has first claims on the company’s cash flows
Asymmetric information models can explain several facts
Signaling arguments can also explain market reactions to payout policy (e.g., why share repurchases are interpreted as good news)
When is a good time to issue equity?
Do we ever see undervalued firms issue equity?
Market frictions and inefficiencies
Although the view of most mainstream financial economists is that markets are fairly efficient most of the time, they also acknowledge that there seems to be instances when this is not true
Other fictions and inefficiency that MM doesn‘t allow for / Problems in real world markets
Bottom line: After come up with optimal capital structure target, need to factor in frictions!
How to come up with a capital structure for a
firm (revised)
Advantages of using leverage
Disadvantages of using leverage
Other things to take into account when determining your optimal capital structure
