DP4181 Stakeholders, Transparency and Capital Structure

Author(s): Andres Almazan, Javier Suarez, Sheridan Titman
Publication Date: January 2004
Keyword(s): dynamic capital structure, equity issuance, market scrutiny, under-investment
JEL(s): G30
Programme Areas: Financial Economics
Link to this Page: cepr.org/active/publications/discussion_papers/dp.php?dpno=4181

Firms that are more highly levered are forced to raise capital more often, a process that leads to the generation of information. Of course, transparency can improve the allocation of capital. When the information about the firm affects the terms under which the firm transacts with its customers and employees, however, transparency can have an offsetting negative effect. Under relatively general conditions, good news improves these terms of trade less than bad news worsens them, implying that increased transparency can lower firm value. In addition, we show that transparency can reduce the incentives of firms and stakeholders to undertake relationship-specific investments, can lead firms to pass up positive NPV investments that require external funding, and can lead firms to choose more conservative capital structures than they would otherwise choose. These effects are likely to be especially important for technology firms that require a reputation for being on the ?leading edge?.