INFORMATIONAL ASYMMETRIES, FINANCIAL STRUCTURE, AND FINANCIAL INTERMEDIATION

Abstract

A MODEL OF CAPITAL-STRUCTURE AND FINANCIAL EQUILIBRIUM IS DEVELOPED IN WHICH ENTREPRENEURS SEEK FINANCING OF PROJECTS WHOSE TRUE QUALITIES ARE KNOWN ONLY TO THEM. THE ENTREPRENEUR'S WILLINGNESS TO INVEST IN HIS OWN PROJECT CAN SERVE AS A SIGNAL OF PROJECT QUALITY. THE RESULTING EQUILIBRIUM DIFFERS IMPORTANTLY FROM MODELS WHICH IGNORE INFORMATIONAL ASYMMETRIES. THE VALUE OF THE FIRM INCREASES WITH THE SHARE OF THE FIRM HELD BY THE ENTREPRENEUR. THE FINANCIAL-STRUCTURE OF THE FIRM TYPICALLY WILL BE RELATED TO PROJECT OR FIRM VALUE EVEN WHEN THERE ARE NO TAXES. FIRMS WITH RISKIER RETURNS WILL HAVE LOWER DEBT LEVELS EVEN WHEN THERE ARE NO BANKRUPTCY COSTS. SIGNALING INCURS WELFARE COSTS BY INDUCING ENTREPRENEURS TO TAKE LARGER EQUITY POSITIONS IN THEIR OWN FIRMS. GRAPH. EQUATIONS. REFERENCES. APPENDIX.