Capital Stucture

1. Capital Stucture Signaling

2. Pemahaman Istilah • 2signal • Verbsig·naledorsig·nalledsig·nal·ingorsig·nal·ling • sig·nal·er or sig·nal·lernoun • Definition of SIGNAL • transitive verb • 1: to notify by a signal <signal the fleet to turn back> • 2a: to communicate or indicate by or as if by signals<signaled the end of an era> • b: to constitute a characteristic feature of (a meaningful linguistic form) • intransitive verb • : to make or send a signal • Examples of SIGNAL • Robinssignal the arrival of spring. • The election results surely signal the start of a new era. • A lock on the suitcase might signal that there's something of value inside. • Did he signal before he made the left turn? • They signaled at me to come over to their table. • He signaled us that it was time to begin the meeting. • The umpire signaled a strike. • First Known Use of SIGNAL1805

3. Signaling • Signal is a message credibly conveying information from informed to uninformed players • It is credible • if it is in the player’s interest to tell the truth • it is too costly to mimic (to lie) by others

4. Capital structure and signaling • Assumptions: • Managers have better information about a firm’s long-run value than outside investors • Managers act in the best interests of current stockholders • Managers can be expected to: • Issue stock if they think stock is overvalued • Issue debt if they think stock is undervalued • As a result, investors view a common stock offering as a negative signal -- managers think stock is overvalued

5. Capital structure and signaling (2) • Signaling theory, suggests firms should use less debt than MM suggest • This unused debt capacity helps avoid stock sales, which depress P0 because of signaling effects

6. Signaling Prospects Through Financing Decisions • One of the key assumptions Modigliani and Miller make in their work is that market information is symmetric, meaning companies and investors have the same information with respect to the company's future projects/investments. This assumption, however, is not realistic. When making capital decisions, a company's management should have more information than an investor, which implies asymmetric information.  • A financing decision is a way in which a company can inadvertently signal its prospects to investors. For example, suppose Newco decides to finance a new project with equity. Newco's additional equity would in fact dilute stockholder value. Since companies typically try to maximize stockholder value, would an equity offering be a bad signal? The answer is yes.  • There would be some benefit from the project to the stockholders; however, the dilution from the offering would offset some of that benefit. If a company's prospects are good, management will finance new projects with other means, such as debt, to avoid giving any negative signals to the market. • Read more: http://www.investopedia.com/exam-guide/cfa-level-1/corporate-finance/signaling-prospects-financing-decisions.asp#ixzz1wyHBmLGr