Multi-Stage Investment, Long-Term Asymmetric Information and Pecking Order Revisited

Following some recent empirical papers we focus on the key feature of "Pecking-order theory" (POT) - the existence and the extent of asymmetric information between firms' insiders and outsiders. We analyze the debt-equity choice for financing a two-stage investment and consider different informational structures. When private information is short-term, equilibria are consistent with POT. When private information is long-term and the extent of asymmetric information regarding firms values is small enough while that regarding the earnings profile over time is large enough, equilibria may exist where high quality firms issue equity which are not consistent with POT. This clarifies the role of asymmetric information in explaining equity issues and provides new tools for researchers testing POT.