Repeated signaling and firm dynamics
Journal
Review of Financial Studies
Subject
Finance
Publishing details
Authors / Editors
Hennessy C;Livdan D;Miranda B
Biographies
Publication Year
2010
Abstract
As an alternative to the pecking order, we develop a dynamic calibratable model where the firm avoids mispricing via signaling. The model is rich, featuring endogenous investment, debt, default, dividends, equity flotations, and share repurchases. In equilibrium, firms with negative private information have negative leverage, issue equity, and overinvest. Firms signal positive information by substituting debt for equity. Default costs induce such firms to underinvest. Model simulations reveal that repeated signaling can account for countercyclical leverage, leverage persistence, volatile procylical investment, and correlation between size and leverage. The model generates other novel predictions. Investment rates are the key predictor of abnormal announcement returns in simulated data, with leverage only predicting returns unconditionally. Firms facing asymmetric information actually exhibit higher mean Q ratios and investment rates
Publication Research Centre
Institute of Finance and Accounting
Available on ECCH
No
