Lec 10: Asymetric Information Flashcards
Why is supply/demand unlikely to explain the negative effect of Seasoned Equity Offerings?
Bond issues do not have similar effects
Negative effects are considerably lower for some industries, such as utilities
Who has bargaining power in the Myers and Majluf model?
The firm has bargaining power. The investors are in Bertrand competition, consistent with large equity markets.
What is the equillibrium concept in the Myers and Majluf model?
It is a Perfect Bayesian Equillibrium, consisting of beliefs, ussie strategy and a market pricing strategy
Why may equity issuance lead to a share price decline in the Myers and Majluf model?
If firm’s assets in the good state are large compared to both the NPV and the assets in place in the bad state, the firm may be better off not issuing in the good state, since it would give away too much of the already valuable assets in place. Issuing then provides the information that the firm is in the bad state.
Why doesn’t the Myers and Majluf model imply a pecking order of debt and equity?
Because the model only considers the choice between issuing equity and not issuing at all. The model may however imply a pecking order between internal finance and equity issuance, which makes the assertion of a pecking order between debt and equity reasonable. The Noe (1988) model considers the explicit choice between issuing debt, issuing equity and not issuing at all.
Why may the Myers and Majluf model imply underinvestment?
The cost to old shareholders of issuing shares at a bargain price may outweigh the project’s NPV. Not ‘issuing’ may be seen as good news, and issuing may be seen as bad news
In the Myers and Majluf model does the assumption that projects have a positive NPV matter? Is the assumption reasonable?
Yes it does matter if NPV is sufficiently negative the firm may not invest with bad information and equity issuance may convey positive informa- tion. Is it reasonable, same question as can the manager precommit to project choice.
What are the implications of letting the manager only choose projects based on NPV?
For NPV projects, this essentially means we end up in the pooling equilibrium
What is a problem of requiring the manager to accept all NPV positive projects?
That whenever a good project is found, shareholders may be tempted to ask the manager not to issue due to dillution effects. This is a problem of commitment
