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Asymmetric Information, Debt Capacity, and Capital Structure

Published online by Cambridge University Press:  05 October 2018

Michael L. Lemmon  and
Jaime F. Zender
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Abstract

Capital structure choice based on costs associated with asymmetric information is examined in order to present a new perspective on the standard pecking order and trade-off theories. In the model, both the face value of debt and the restrictiveness of the associated debt covenants are chosen as part of the financial structure, allowing a more complete characterization of this decision. Debt structure choice balances ex ante adverse selection against ex post moral hazard, providing a natural integration of the pecking order and trade-off theories and the development of interesting empirical implications.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 54 , Issue 1 , February 2019 , pp. 31 - 59
Copyright
Copyright © Michael G. Foster School of Business, University of Washington 2018 

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Footnotes

1

We are especially indebted to Phil Dybvig, Michael Fishman (the referee), and Jeff Zwiebel for insightful comments on a previous draft.  We also thank Matthias Kahl, Chris Leach, Paul Malatesta (the editor), Iulian Obreja, Paul Pfleiderer, Roberto Pinheiro, Michael Roberts, Chris Yung, and seminar participants at Georgetown University, Stanford University, the University of Nebraska, the University of Texas at Austin, the University of Texas at Dallas, and Washington University in St. Louis.

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