Capital Structure with Information About the Upside and the Downside

Pierre Chaigneau

♦ We introduce two dimensions of uncertainty, about the upside and the downside of an asset, in a model of asset valuation under asymmetric information. This justifies capital structures with equity and risky debt for information revelation purposes. However, a capital structure with only one information-sensitive security, equity, can be optimal when investors are less informed about the dimension that matters more for valuation. This is relevant for innovative firms with a large upside subject to strong information asymmetries, which often have abnormally low leverage, and for firms at an intermediate stage of their life cycle that don’t issue risky debt.

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