Optimal Capital Structure with Stock Market Feedback

Caio Machado, Ana Elisa Pereira*

*Corresponding author for this work

Research output: Contribution to journalArticlepeer-review

1 Scopus citations

Abstract

This article studies optimal capital structure when firms learn from financial markets. We present a tractable model of stock market feedback with imperfect information aggregation. Debt issuance affects speculators’ incentives to trade both directly, by changing the payoff structure of equity holders, and indirectly, through an asset substitution effect. We show that issuing debt can increase market informativeness and firm value, and may eliminate a coordination failure equilibrium with no provision of market information. We derive the optimal capital structure in this setting and present novel empirical predictions regarding the relationship between market frictions, market informativeness, and capital structure. Once the effect of debt on market informativeness is considered, risky debt does not necessarily lead to risk shifting.
Original languageEnglish
Pages (from-to)1329-1371
Number of pages43
JournalReview of Finance
Volume27
Issue number4
DOIs
StatePublished - 1 Jul 2023

Bibliographical note

Publisher Copyright:
© 2022 The Author(s). Published by Oxford University Press on behalf of the European Finance Association. All rights reserved.

Keywords

  • Capital structure
  • Feedback effect
  • Financial markets
  • Information aggregation

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