Asymmetric Information and the Pecking (Dis)Order

In this paper we show that when growth options represent a significant component of overall firm value, equity financing can dominate (i.e., be less dilutive than) debt financing under asymmetric information. In particular, we find that equity is more likely to dominate debt for younger firms with larger investment needs and with riskier growth opportunities. Thus, our model can explain why high-growth firms may prefer equity over debt, and then switch to debt as they mature. We also fid that equity financing is relatively more attractive when a firm already has debt in its capital structure. In addition, equity can dominate debt in multidivisional firms. Finally, we provide new predictions on the cross-sectional variation of capital structures.