The author is indebted to Jerome Detemple, Nalin Kulatilaka, and Mark Loewenstein for invaluable advice. The author especially thanks an anonymous referee and Arnold R. Cowan (the Editor) for many helpful suggestions. Comments from seminar participants at Boston University and Ling Tung University are also appreciated. All remaining errors are mine.
Information Asymmetry and Corporate Investment Decisions: A Dynamic Approach
Article first published online: 31 MAR 2008
©2008, The Eastern Finance Association
Volume 43, Issue 2, pages 241–271, May 2008
How to Cite
Tsai, S.-C. (2008), Information Asymmetry and Corporate Investment Decisions: A Dynamic Approach. Financial Review, 43: 241–271. doi: 10.1111/j.1540-6288.2008.00193.x
- Issue published online: 31 MAR 2008
- Article first published online: 31 MAR 2008
- growth option;
- investment distortion;
- information asymmetry;
- endogenous default
This paper develops a dynamic model of the financing and operating decisions of firms in the presence of information asymmetry. When the value of growth opportunities is not fully recognized, securities are undervalued, thus influencing the financing and investment decisions. The agency-based underinvestment problem is re-examined under information asymmetry. For firms with greater growth opportunities, the investment distortion resulting from information asymmetry is especially significant. Information asymmetry also increases the expected bankruptcy cost. The cost of information asymmetry in terms of both the firm value and the information spread under the optimal capital structure could be substantial.