REAL OPTION SIGNALING GAMES OF DEBT FINANCING USING EQUITY GUARANTEE SWAPS UNDER ASYMMETRIC INFORMATION

2020 ◽  
Vol 23 (05) ◽  
pp. 2050036
Author(s):  
QIUQI WANG ◽  
YUE KUEN KWOK
Keyword(s):  
Real Option ◽  
Debt Financing ◽  
Bank Loan ◽  
Information Cost ◽  
Information Costs ◽  
Investment Opportunity ◽  
High Type ◽  
Investment Timing ◽  
Funding Cost ◽  
Financing Choice

We analyze the real option signaling game models of debt financing of a risky project under information asymmetry, where the firm quality is only known to the firm management but not outsiders. The firm decides on the optimal investment timing of the risky project that requires upfront fixed funding cost and subsequent operating costs. The fixed funding cost is financed via either direct bank loan or entering into a three-party equity guarantee swap (EGS) that involves a bank granting the loan and third party guarantor. Under the EGS agreement, the guarantor is obligated to pay all the future coupon stream to the bank upon default of the firm. In return for the provision of the guarantee, the guarantor obtains certain proportional share of equity of the firm at the time when the swap agreement is signed. The share of equity demanded by the guarantor depends on the outside investors’ belief on the firm quality. The low-type firm has the incentive to mimic the investment strategy of being high-type in terms of investment timing and share of equity. The high-type firm may adopt the appropriate separating strategy by speeding up investment or choosing an alternative financing choice. The resulting loss of the real option value of the investment opportunity represents the information cost under separating strategies. We examine the incentive compatibility constraints faced by the firm under different quality types and discuss characterization of the separating and pooling equilibriums. Unlike the usual assumption of perpetuity of investment opportunity, our real option model assumes the time window of the investment opportunity to be finite. We explore how the information cost and nature of separating and pooling equilibriums evolves over the finite time span of the investment opportunity. The information costs and investment thresholds exhibit interesting time-dependent behaviors. We examine the firm’s investment and financing choice between EGS and the direct bank loan against time and other parameters via comparison of the corresponding information costs and investment thresholds.

Signaling game models of equity financing under information asymmetry and finite project life

2019 ◽  
Vol 06 (01) ◽  
pp. 1950002 ◽  
Author(s):  
Qiuqi Wang ◽  
Yue Kuen Kwok
Keyword(s):  
Time Window ◽  
Abnormal Returns ◽  
Investment Strategy ◽  
Optimal Time ◽  
Signaling Game ◽  
Information Costs ◽  
Investment Opportunity ◽  
Equity Financing ◽  
High Type ◽  
Investment Timing

We develop the real option signaling game models of equity financing of a risky project under asymmetric information, where the firm quality is known to the firm management but not outside investors. Unlike the usual assumption of perpetuity of investment, we assume that the time window of the investment opportunity has a finite time horizon. The firm chooses the optimal time to issue equity to raise capital for the investment project. The number of shares of equity issued to fund the project depends on the outside investors’ belief on the firm quality. The low-type firm has the incentive to sell overpriced securities through mimicking the investment strategy of the high-type firm in terms of investment timing and number of equity shares. On the other hand, the high-type firm may adopt the separating strategy by imposing mimicking costs on the low-type firm. We examine the incentive compatibility constraints faced by the firm under different quality types and discuss characterization of the separating and pooling equilibriums. We also explore how the separating and pooling equilibriums evolve over the time span of the investment opportunity. The information costs and abnormal returns exhibit interesting time dependent behaviors, in particular, at time close to expiry of the investment opportunity.

scholarly journals Missed Opportunities: Optimal Investment Timing When Information is Costly

2007 ◽  
Vol 42 (2) ◽  
pp. 467-488 ◽  
Author(s):  
Graeme Guthrie
Keyword(s):  
Real World ◽  
Real Option ◽  
Optimal Investment ◽  
Investment Opportunity ◽  
Missed Opportunities ◽  
Investment Timing ◽  
Real Option Analysis ◽  
Amount Of Information ◽  
Optimal Delay

AbstractReal option analysis typically assumes that projects are continuously evaluated and launched at precisely the time determined to be optimal, but real world projects cannot be managed in this way because of the costs of formally evaluating an investment opportunity. This paper shows that immediate investment is more attractive if evaluation costs are high or the amount of information to be revealed by an evaluation is large. The optimal delay until a reevaluation is long if evaluation costs are high or the amount of information to be revealed by an evaluation is small. The reduction in the value of project rights is especially severe when the value of the completed project is strongly mean reverting because then precision in investment timing is particularly important.

Vertical Boilerplate

2017 ◽  
Author(s):  
James Gibson
Keyword(s):  
Market Power ◽  
Real World ◽  
Empirical Work ◽  
Full Scale ◽  
Market Mechanism ◽  
Law School ◽  
Information Cost ◽  
Information Costs ◽  
Policy Proposals ◽  
Radical Solution

Despite what we learn in law school about the “meeting of the minds,” most contracts are merely boilerplate—take-it-or-leave-it propositions. Negotiation is nonexistent; we rely on our collective market power as consumers to regulate contracts’ content. But boilerplate imposes certain information costs because it often arrives late in the transaction and is hard to understand. If those costs get too high, then the market mechanism fails. So how high are boilerplate’s information costs? A few studies have attempted to measure them, but they all use a “horizontal” approach—i.e., they sample a single stratum of boilerplate and assume that it represents the whole transaction. Yet real-world transactions often involve multiple layers of contracts, each with its own information costs. What is needed, then, is a “vertical” analysis, a study that examines fewer contracts of any one kind but tracks all the contracts the consumer encounters, soup to nuts. This Article presents the first vertical study of boilerplate. It casts serious doubt on the market mechanism and shows that existing scholarship fails to appreciate the full scale of the information cost problem. It then offers two regulatory solutions. The first works within contract law’s unconscionability doctrine, tweaking what the parties need to prove and who bears the burden of proving it. The second, more radical solution involves forcing both sellers and consumers to confront and minimize boilerplate’s information costs—an approach I call “forced salience.” In the end, the boilerplate experience is as deep as it is wide. Our empirical work should reflect that fact, and our policy proposals should too.

scholarly journals Organizational Form, Performance And Information Costs In Small Businesses

2011 ◽  
Vol 17 (4) ◽  
Author(s):  
Alberto M. Bento ◽  
Lourdes F. White
Keyword(s):  
Agency Theory ◽  
Small Businesses ◽  
Organization Design ◽  
Organizational Form ◽  
Decision Variable ◽  
Information Cost ◽  
Information Costs ◽  
Font Size ◽  
Empirical Results ◽  
Design Theories

<p class="MsoNormal" style="text-align: justify; margin: 0in 37.8pt 0pt 0.5in; tab-stops: 387.0pt;"><span style="mso-bidi-font-style: italic;"><span style="font-size: x-small;"><span style="font-family: Batang;">This extends agency theory to introduce organizational form as a decision variable that directly influences risk bearing and the costs of control in small businesses.<span style="mso-spacerun: yes;">&nbsp; </span>Based on information cost and organization design theories, we propose a relationship between organizational form and information costs.<span style="mso-spacerun: yes;">&nbsp; </span>Our empirical results reveal that organizational form is the first or second most important decision variable related to performance and information costs in small businesses. </span></span></span></p>

scholarly journals Role of Business Age, Scale & Risk in Debt Financing Choices for the Pakistani Textile & Apparel Industry

e-Finanse ◽  
2020 ◽  
Vol 16 (3) ◽  
pp. 119-136
Author(s):  
Zahid Bashir ◽  
Muhammad Usman Arshad ◽  
Muhammad Asif ◽  
Muhammad Abbas ◽  
Hasnain Ali
Keyword(s):  
Debt Financing ◽  
Future Research ◽  
Debt Ratio ◽  
Equity Financing ◽  
Tax Shield ◽  
Total Debt ◽  
Textile And Apparel ◽  
Financing Choice

Abstract The motivation for this research enquiry is to identify the role of the business age, size and risk for the choice of debt financing in the textile and apparel sector of Pakistan along with other controlled factors. The textile and apparel sector of Pakistan comprises 464 listed entities as the targeted population while the study randomly finalized 60 firms as the sample after carefully analyzing the required information from the financial statements during the annual revenue streams of 2013-2019. The predicted variable for this research enquiry is measured by short, long and total-debt ratios while the predictor variables include the business age, firm’s scale and risk. In addition, the research includes tax shield, tangibility, liquidity, profitability, and growth as the controlling factors. The study estimated that the choice of total-debt ratio is strongly affected by business age, size and risk along-with tax shield, tangibility, liquidity and profitability while the choice of short-term debt ratio mainly depends upon the firm’s scale and age along with the tax shield. In addition, the choice of long-term debt ratio is strongly explained by the firm’s scale and age along with the tax shield, liquidity and profitability. The estimated evidence provides management with the implications for the textile and apparel sector of Pakistan to consider as significant factors in deciding the debt financing choice of this sector. The estimated evidence of this research enquiry applies to the non-financial textile sector only and cannot be generalized to the financial sector. Future research may enhance the financing choice towards the inclusion of equity financing with the same set of variables.

scholarly journals Um Modelo de Opções Reais com Investimento Incerto e Seqüencial e com Tempo para Construir

2005 ◽  
Vol 3 (2) ◽  
pp. 141 ◽  
Author(s):  
Guilherme B. Martins ◽  
Marcos Eugênio Da Silva
Keyword(s):  
Differential Equation ◽  
Real Option ◽  
Investment Decision ◽  
Maximization Problem ◽  
Investment Opportunity ◽  
Rule Based ◽  
Construction Period ◽  
Time To Build ◽  
Option Model ◽  
A Company

This article develops a real option model with uncertain and sequential investment and with time to build. The model includes options to entry and to exit the activity and addresses the maximization problem of a company in view of the investment opportunity. The differential equation of the asset is obtained by using dynamic programming and risk neutral evaluation. Particularly, for the construction period, the differential equation is partial and elliptical, which demands the use of numeric methods. The main results of the article are that (i) with uncertain and sequential investment and with time to build, the waiting value, which creates a gap between the investment decision rule based on NPV and that based on a real option model, may not very significant and (ii) the increase in uncertainty may anticipate the decision to investment.

scholarly journals Investment Timing and Incentive Costs*

2019 ◽  
Vol 33 (1) ◽  
pp. 309-357 ◽  
Author(s):  
Sebastian Gryglewicz ◽  
Barney Hartman-Glaser
Keyword(s):  
Moral Hazard ◽  
Real Option ◽  
Natural Source ◽  
Investment Timing ◽  
Editorial Decision ◽  
Incremental Form ◽  
The Cost

Abstract We analyze how the costs of smoothly adjusting capital, such as incentive costs, affect investment timing. In our model, the owner of a firm holds a real option to increase a lumpy form of capital and can also smoothly adjust an incremental form of capital. Increasing the cost of incremental capital can delay or accelerate investment in lumpy capital. Incentive costs due to moral hazard are a natural source of costs for the accumulation of incremental capital. When moral hazard is severe, delaying investment in lumpy capital is costly, and overinvesting relative to the first-best case is optimal. Received January 24, 2017; editorial decision March 15, 2019 by Editor Itay Goldstein.

Sign in / Sign up

Export Citation Format

Share Document