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A Theory of Capital Structure Relevance under Imperfect Information
Author(s) -
HEINKEL ROBERT
Publication year - 1982
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.1982.tb03608.x
Subject(s) - cost of capital , capital structure , economics , cash flow , capital market imperfections , unobservable , monetary economics , debt , microeconomics , imperfect , business , equity (law) , finance , financial economics , incentive , capital market , econometrics , linguistics , philosophy , political science , law
Firms raise debt and equity capital to finance a positive net present value project in perfectly competitive capital markets; firm insiders know the function generating the random firm cash flow but potential capital suppliers do not. Taking into account the incentives of insiders to misrepresent their firm type, capital suppliers attempt to design financing mixes of debt and equity that eliminate the adverse incentives of insiders and correctly price securities. Necessary conditions for a costless separating equilibrium are developed to show that the amount of debt used by a firm is monotonically related to its unobservable true value.