Does asymmetric information affect firm's financing decisions?

Abstract

PurposeThe authors examine the impact of asymmetric information on firm's financing decisions, the feedback effect of changes in capital structure on the level of asymmetric information, and the speed of adjustments in capital structure on its target leverage.Design/methodology/approachThe authors extract the data on 280 non-financial firms listed in the Pakistan Stock Exchange (PSX) from the DataStream. The authors implement the generalized method of moments (GMM), complemented by the fixed effect model (FEM) to estimate the model coefficients.FindingsThe authors find that asymmetric information significantly affects the financing decisions; and that on average, firms adjust 26% of the total debt toward their target capital structure. The negative effect from the difference between the observed and target changes in leverage on asymmetric information confirms that capital structure changes act as a signal for future profitability and helps the management to lower its level of asymmetric information.Originality/valueThe findings offer fresh insight into the effect of asymmetric information on financing decisions, as well as the speed of adjustment of capital structure toward its target leverage, in the context of the firms working in emerging markets like Pakistan. To the authors’ best knowledge, this is the first study to investigate the impact of asymmetric information on financing decisions that incorporate firm's age, size and the global financial crises 2007–2008. The authors construct an asymmetric information index using both accounting and finance measures of asymmetry.