Ppt Asym Info

7/27/2019 Ppt Asym Info

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Corporate Finance:Asymmetric information and capitalstructure the lemons problem

Yossi SpiegelRecanati School of Business


2/30

Akerlof, QJE 1970

The Market for Lemons: QualityUncertainty and the MarketMechanism


3/30

Corporate Finance 3

The lemons problem An entrepreneur establishes a firm

Cash flow is x ~ U[0,1]

The entrepreneur privately observes x

How much will investors pay for the firms equity?

Suppose the price is p should investors pay it?

The entrepreneur will agree to sell only if x p

Given p, investors should pay E(x|x p). With uniform dist.,

E(x|x p) = p/2.

It is impossible to sell the firm!


4/30

Corporate Finance 4

Crucial assumptions for the lemons

problem The entrepreneur does not have to sell if he

does not want to sell

The entrepreneur knows x but investors donot and investors know this fact

The value of the firm is the same for theentrepreneur and the investors

The entrepreneurs willingness to sell impliesthat x p


5/30

Corporate Finance 5

Overcoming the lemons problem Cash flow x is drawn from CDF F(x) on [0,)

The entrepreneurs payoff: p x

The buyers payoff is bx p, b 1 (the buyer can improvethe firm there are gains from trade)

A seller will sell iff p x

The buyer will buy iff

)(

)( 0

pF

xxdFx

p

=

x

pbpxb


6/30

Myers and Majluf, JFE 1984

Corporate Financing and InvestmentDecisions when Firms have Information thatInvestors Do Not Have


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Corporate Finance 7

The model The timing:

Existing value, x, is drawn from somedist.

The mean of x is

A firm worth x caninvest I in a projectthat yields R > I

Stage 0 Stage 2Stage 1

The firm decideswhether or not totake the project and

how to finance it

Cash flow is realized

x


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Corporate Finance 8

The full information case Suppose that the firm issues equity

that gives investors of the firm

In order to raise I dollars:

The entrepreneurs payoff:

Rx

IIRx

+==+ )(

( )( ) ( ) IRxRxRx

IRxRxU +=+

+

+=+= 1


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Corporate Finance 9

Asymmetric information binary

case: x {xL, xH} Suppose we have a pooling equil. and

both type finance the investment


The entrepreneurs payoff:

RxIIRx+==+

)(

( )( ) ( )RxRx

IRxRxU +

+

+=+=

1


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Corporate Finance 10

Will both types finance? The entrepreneur will invest iff U > x (value w/o investing)

Type L is subsidized by type H because

Both types invest only if U > x for type H

O/w only type L invests and type H forgoes the investmentalthough it has NPV > 0

( )( )( ) ( )

( ) ( )43421

mispricing

++=

+++=

+

+++=

++

+

=

RxRxIR

RxRxIRxR

Rx

RxxRxIRx

xRxRx

IRx

xU

HL xxx


11/30


Asymmetric information:

continuous case: x ~ F(x) on [0,) Let be the highest x such that the entrepreneur invests

The expected value of the firm given :


The entrepreneurs payoff:Rxx

IIRxx

+==+

)())((

( )( )( )

( )( )Rx

Rxx

IRxxRxU +

+

+=+=

1

x

( )xxxExF

xxdFxx

x

==

)(

)()( 0

x


12/30


How is determined? The entrepreneur will invest iff U > x (value

w/o investing)

is determined s.t. the payoff U = x:x

x

045

x

( )( )

( )RxRxx

IRxxU +

+

+=

x


13/30


How is determined? is determined by

Solving the two equations yield

( )( )

( )

( )

( ) xR

IIRxxxRx

Rxx

IRxx

xU

=+=++

+

444 3444 21

xx

( )xxxExx =)(

x


14/30


Implications The entrepreneur will invest iff

If the entrepreneur uses safe debt:

This is also the payoff when using RE

Pecking order: RE Debt Equity

xx

IRxDRxU +=+=


15/30


Price reactions Before investing, the expected value of the firm is

Conditional on passing on the investment project, themarket learns that hence, the expected value is:

Conditional on investing, the market learns that ;hence, expected value of the firm is

xx >

( ) ( )xxxExdFxF

xNE

x

>=

=

|)()(1

xx

( ) ( ) IRxxxEIRxdFxF

xYE

x

+=+= |)()(0

{ ( ) ( )IRxFxxdFxFx

xFIRxdFxF

x

xFE x

x

+=

+

+=

)()()(1)(1)()()(highisx

thatProb.0lowisx

thatProb.43421


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Price reactions to not investing

Not investing is good news

( )

( )

( )

( ) ( )( )

( )

( )[ ] 0|)(

|)(

||)(

)()(

)()(1

)(

)()()(1

)(

)()()(1

)(

ofdef.by the

0

0

>>>

>=

+>=

=

+=

=

xxxxExF

xRIxxxExF

IRxxxExxxExF

IRxdFxF

xxdF

xF

xxF

IRxFxdFxxF

xxxdF

IRxFxxdFxF

xENE

xxR

I

x

x

x

x

x

444 3444 21


17/30


Price reactions to investing

Investing is bad news

( )

( )( )

( ) ( )

( ) ( ) ( ) ( )[ ]

( ) ( )

( ) ( )[ ] 0|)(1

|)(1

||)(1

)()(1

)()(

)(1

)(1)()(

)(

)()()(

)(

0

0

0

=

>+=

+

=

+

+=

+=

xxxExxF

xxxEx

R

IxF

xxxEIRxxxExF

IRxdFxF

xxdF

xF

xxF

IRxFxdFxxF

xxxdF

IRxFxIRxdFxF

xEYE

x

x

x

x

x


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Yosha, JFI 1995

Information Disclosure Costs andthe Choice of Financing Source


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The entrepreneurs type is F()

is disclosed if the entrepreneur raises funds from the capital market but not if heborrows money from a bank

The rivals payoff: R = R(x) - c(x) R(x) > 0 > R(x), c(x) > 0, c(x) > 0

The entrepreneurs payoff: E = (x(),) Ex < 0,

E > 0 (higher means a higher type)

An entrepreneurneeds to raisefunds to invest: Bank Capital market


A rival observes theentrepreneursdecision and takesaction x, that hurtsthe entrepreneur



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The rivals action given The rivals chooses x to maximize

xx()

R(x)

c(x)

x()The entrepreneuris better off if the

rival believes that is low

)()( xcxRR

=


21/30


Bank debt vs. capital market Bank debt: the rival does not know and hence uses his belief ;

hence the rival takes an action

Capital market: the rival observes and takes an action x();the firm incurs an issuing cost

The effect of on E with bank debt (holding fixed):

The entrepreneurs payoff (the positive sign is by assumption):

0,,

>

=

x

d

xd EE

)(x

( )( ) ( )( ) ( ){

( )( ) 0,',,

)(

)(

)(

>

+

=

++

44 344214434421

xx

x

x

d

xd EEE


22/30


The rivals action given

Av. quality of firms that work with banks:

,xE

( )( ) ,xE

Capital market Bank

*)(1

)( *

F

dF

=


23/30


Implications Good firms work with banks, firms which raise

funds in the capital market are less good

pecking order

* The av. quality of firms which issuein the capital market

Positive price reactions to private placements

The literature on info. revelation shows howeverthat info. revelation can lead to either positive ornegative reactions by 3rd parties (e.g., rivals)


24/30

Rock, JFE 1986

Why New Issues are Underpriced


25/30


Stylized facts about IPOs Short-run equity underpricing: The closing price on the first day of

trading is on av. above the offering price

Weiss, Hanely and Ritter, Going Public,The New Palgrave Dictionary(Table 1), reports that the av. increase in the stock price shortly afterIPOs is 16.4% in the U.S. during the period 1960-1987 31.9% in Japan during the period of 1979-1989 79% in Korea during the period 1984-1990

149.3% in Malaysia during the period 1979-1984

Long-run equity overpricing: For several years following the IPO,the returns on IPOs are on av. lower than those on comparable stocks the av. cumulative matching firm-adjusted return 36 months after the IPO

is -15.08% (Ritter,JF1991)

Oversubscription: IPOs are typically oversubscribed and eachparticipant receives just a fraction of his order


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The firms value, x, is drawn from CDF F(x) on [0,)

The mean of x is

Each investor has K to invest

Investors have enough to invest but one investor is notenough:

An entrepreneurgoes for an IPO


N+1 investors decidewhether or not toparticipate


x

KxNK >>


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All N+1 investors are uninformed The value of equity is

Each investor has K to invest and hence demands

There is oversubscription:

Since total supply is 1, investors are rationed and each one gets:

( ) { 1

1

1

1

demandIndividual

investoreachofShare

+=

+ Nx

K

xKN

43421

)

xE =

xK /

32143421assumptionBydemandAggregate

1

)1( >>+x

NK

x

KN


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N uninformed investors and 1

informed investor The informed investor participates in the IPO iff E x

Uninformed investors do not observe the informed investors

decision (if they could they would infer x)

If uninformed investors participate, they get: 1/(N+1) if E x (the informed investor participates) 1/N if E > x (the informed investor does not participate)

The net expected payoff of an uniformed investor:

In a competitive capital market, YU = 0

( ) ( )

+

+=E

E

U xdFEx

N

xdFEx

N

Y )(

1

1)(

1

0


29/30


Underpricing in IPOs The condition for a competitive equilibrium:

Rewriting:

Multiplying by N and rearranging:

Less underpricing as N gets large

( ) ( ) 0)(1

1)(

1

0

=+

+=

E

E

UxdFEx

NxdFEx

NY

( )

( )( )

=

+=

++

E

E

xdFExNNN

Ex

xdFExNNN

Ex

0)(1

1

)(1

1

1

xxdFN

ExxEE

)(1

ngUnderprici


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Post IPO share price After the IPO the market observes the participation and

learns whether the informed investor participated or not

If the informed investor did not participate then x < E new value of equity

If the informed investor participated then x > E newvalue of equity

ExdF

EF

xE

E

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