Essays on financial signalling

Guan Hua Lim, University of Pennsylvania


This dissertation addresses financial signalling in (a) a multi-period setting where the owner-manager learns about his true type sequentially over time, and (b) a two-audience setting. The first essay takes the simple single-period two-type model and extends it to two periods and four types with sequential type revelation. This allows us to expand the signalling space and achieve full type separation with four types. The major contributions of this essay are as follows. First, it provides us with a general framework within which to study the interactions between capital structure, dividend and investment decisions, and how these affect the existence and character of the resulting signalling equilibrium. Second, it casts a cautionary note to any empirical prediction derived from a single-period model. Within the general setting of our model, we find that the empirical relations between the firm's quality and commonly used financial signals--leverage, level of equity retention, size of capital issue, and dividends--are no longer simple or unambiguous. Rather, they are very sensitive to the specifications of the model, such as, the ordering of any intermediate cash flows. The second essay re-examines the predominance of pooling equilibria in models where the firm has to consider, when deciding whether to reveal its type, the effect its decision would have on its product market in terms of increased competition and reduced profits. We present a simple two-audience financial signalling model where the firm acts as an asymmetrically informed Cournot duopoly in the product market. Within the framework of this model, we study the functions random returns and managerial risk aversion play in determining the type of outcome attainable in equilibrium. The main results of the second essay can be summarized as follows. With risk-free debt and risk-neutral managers, the only attainable equilibrium is "pooling" with positive outside equity financing. The introduction of risky debt, on the other hand, enables us to support a pure-debt pooling equilibrium. However, to achieve separation, managers must also be sufficiently risk-averse.

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Recommended Citation

Lim, Guan Hua, "Essays on financial signalling" (1992). Dissertations available from ProQuest. AAI9235170.