Corporate financing and investment decisions when firms have information that investors do not have

Abstract

NBER WORKING PAPER SERIES CORPORATE FINANCING AND INVESTMENT DECISIONS WHEN FIRMS HAVE INFORMATION THE INVESTORS DO NOT HAVE Stewart C. Myers Nicholas S. Majiuf Working Paper No. 1396 NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 July 19814 The research reported here is part of the NBER's research program in Financial Markets and Monetary Economics. expressed are those of the authors and not those of the National Bureau of Economic Research. Any opinions NBER Working Paper #1396 July 1984 Corporate Financing and Investment Decisions When Firms Have Information That Investors Do Not Have ABSTRACT This paper considers a firm that must issue common stock to raise cash to undertake a valuable investment opportunity. Management is assumed to know more about the firm's value than potential investors. Investors interpret the firm's actions rationally. An equilibrium model of the issue-invest decision is developed under these assumptions. The model shows that firms may refuse to issue stock, and therefore may pass up valuable investment opportunities. The model suggests explana- tions for several aspects of corporate financing behavior, including the tendency to rely on internal sources of funds, and to prefer debt to equity if external financing is required. Extensions and applications of the model are discussed. Stewart C. Myers Finance Section Sloan School of Management M.I.T. 50 Memorial Drive Cambridge, MA 02139 Nicholas S. Maj luf Depto. …

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