Signalling Model

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This file is prepared to address the signalling issue in finance
  Corporate Finance:Asymmetric information and capital structure –signaling Yossi SpiegelRecanatiSchool of Business  Ross, BJE 1977  “The Determination of Financial Structure: The Incentive-SignallingApproach ”   Corporate Finance  3 The model  The timing:  Cash flow is x ~ U[0,T], where T ∈ {L,H}, L < H  T is private info. to the firm  The capital market believes that T = H with prob. γ  In case of bankruptcy, the manager bears a personal loss C  The manager’s utility: U = V –C x Prob. of bankruptcy The firm issues debt with face value D Stage 0Stage 2Stage 1 The capital market observes D and updates the belief about the firm’s typeCash flow is realized  Corporate Finance  4 The full information case  The value of the firm when T is common knowledge:  With uniform dist.:  The manager’s utility:  The manager will not issue debt T  DC  x DF C  xU  T T   −=×−= ˆ)(ˆ ( )  T T  DT  D DT   x xdF  D x x DdF  x xdF V  ˆ)()()( 0 =−++= ∫∫∫ 2 / ˆ  T  x T   =
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