Information Asymmetry and Financing Decisions


  • *We thank an anonymous referee, Daniel Höchle, Dusan Isakov, Iwan Meier, Vefa Tarhan, Heinz Zimmermann, Sudipto Dasgupta (the editor) as well as participants at the 2009 Midwest Finance Association (MFA) Meeting in Chicago, the 2009 European Financial Management Association (EFMA) Meeting in Milan, the 2009 Northern Finance Association (NFA) Meeting in Niagara-on-the-Lake, and the 2009 Financial Management Association (FMA) Meeting in Reno for comments.

Wolfgang Drobetz Institute of Finance University of Hamburg Von-Melle-Park 5 20146 Hamburg Germany


This study conducts tests of the pecking order theory using an international sample with more than 6000 firms over the period from 1995 to 2005. The high correlation between net equity issuances and the financing deficit discredits the static pecking order theory. Rather than analyzing the predictions of the theory, we test its core assumption that information asymmetry is an important determinant of capital structure decisions. Our empirical results support the dynamic pecking order theory and its two testable implications. First, the probability of issuing equity increases with less pronounced firm-level information asymmetry. Second, firms exploit windows of opportunity by making relatively larger equity issuances and build up cash reserves (slack) after declines in firm-level information asymmetry. Firms from common law countries use parts of their proceeds from an equity issuance to redeem debt and to rebalance their capital structure. These findings are consistent with a time-varying adverse selection explanation of firms' financing decisions.