According to the signaling theory of capital structure, firms first use common equity for their capital, then use debt if and only if they can raise no more equity on "reasonable" terms. This occurs because the use of debt financing signals to investors that the firm's managers think that the future does not look good. a. Trueb. False

Question

Business

Araceli

26 January, 08:03

According to the signaling theory of capital structure, firms first use common equity for their capital, then use debt if and only if they can raise no more equity on "reasonable" terms. This occurs because the use of debt financing signals to investors that the firm's managers think that the future does not look good. a. Trueb. False

+2

Answers (2)

Know the Answer?

Jadiel Reeves · Answer 1

B) false

Explanation:

The signalling theory deals with differences in information between stockholders and management. If managers believe that the stock is undervalued, they will issue debt. On the other hand, if managers believe that the stock is overvalued, they will issue stock. An increase in debt is a sign that the company is doing very well and that management is confident about the company's outcome.

Russell Lyons · Answer 2

False

Explanation:

This statement is false because firms are always known for the issuance of debts prior to new stock. This is because they find issuing debt is way cheaper. Because of the cheapness of issuing debt, this method is preferred to using common equity for their capital. The use of debt financing may not signal any message to managers that the future does not look good.