Managerial Preference, Asymmetric Information, and Financial Structure



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    • School of Accountancy, University of Waterloo, Waterloo, Canada. Comments of Phelim Boyle, Michael Brennan, an anonymous reviewer, and seminar participants at the Capital Markets Workshop, The University of Toronto, and The Accounting Group, The University of Waterloo, are gratefully acknowledged. A previous version of this paper was presented at the 1986 Western Finance Association Annual Meeting. All errors should be attributed to the author. Financial support received from The Centre for Research and Education in Accounting, The University of Waterloo, is much appreciated.


If firm performance affects managers' wealth or reputation, preferences of managers dominate firms' financing decisions. When information about real asset investment is symmetric, managers finance exclusively with equity. If managers know more about asset quality than do investors and if managers are sufficiently risk averse, they signal high-quality projects with debt. Increases in collateral value decrease risky debt use. Increases in interest rates that do not change productive opportunities increase debt use. The explanation for these and further results is based on underpricing of equity and overpricing of debt at the margin.