Myers and Majluf (1984)
20
Charles B. Cadsby, Murray Frank, Vojislav Maksimovic, Review of Financial Studies 3(3), 315-342 (1990)
description
“Pooling, Separating, and Semiseparating Equilibria in Financial Markets: Some Experimental Evidence”. Charles B. Cadsby, Murray Frank, Vojislav Maksimovic, Review of Financial Studies 3(3), 315-342 (1990). Myers and Majluf (1984). - PowerPoint PPT Presentation
Transcript of Myers and Majluf (1984)
Charles B. Cadsby, Murray Frank, Vojislav Maksimovic, Review of Financial Studies 3(3), 315-342
(1990)
Question: How do investors and firms deal with asymmetric information?
Firms have information that investors do not about their quality. How do firms and investors interact to fund projects?
Two types of firms, i = H, L Each firm gets
• Ai if they do not undertake a project
• (1-s)(Bi) if they undertake the project• Therefore, firms should undertake a project iff
E(1-s)(Bi) > Ai
Each investor gets• 0 if no project is undertaken• sBi – C if they finance the project• Therefore, investors should bid as long as
sE(Bi) > C s = C/sE(Bi)
With asymmetric information, H firms will have to give more equity than they would with symmetric information.
Pooling equilibria – all projects are undertaken• Amount H firms lose due to uncertainty less
than their gain from the project Separating equilibria – only L firms
undertake projects• Amount H firms lose due to uncertainty greater
than their gain from the project
Let’s test this experimentally! When theory predicts a unique equilibrium, will it happen?
When theory predicts multiple equilibria, which will occur?
NB: In the interest of time, I will not discuss semiseparating equilibria or signaling models, though these are important parts of the Cadsby et. al. paper.
If I tell you whether the firm was H or L.
Investors should demand s* such that• s* (1250) = 300 s* = 24% for H firms• s* (625) = 300 s* = 48% for L firms
Payoffs to firms would be• 76% of 1250 = 950 for H firms• 52% of 625 = 325 for L firms
Both firms will undertake projects.
No New Project
New Project
H Firms 500 1250
L Firms 250 625
I did not tell you whether the firm was H or L.
Now beliefs matter – as an investor, it matters what I believe is, given you offer me a project, the probability that you are H or L.
No New Project
With New Project
H Firms 625 1250
L Firms 300 750
Potential belief #1: Both firms undertake all projects.
Investors demand:• s* (0.5 x 1250 + 0.5 x 750) = 300 s* =
30% Firms get:
• 70% of 1250 = 875, if H undertake• 70% of 750 = 525, if L undertake
Beliefs work!
No New Project
With New Project
H Firms 625 1250
L Firms 300 750
Potential belief #2: Only L firms undertake projects.
Investors demand:• s* (750) = 300 s* = 40%
Firms get:• 60% of 1250 = 750, if H undertake• 60% of 750 = 450, if L undertake
Beliefs do not work.
No New Project
With New Project
H Firms 625 1250
L Firms 300 750
Therefore, we should have a pooling equilibrium where every project is undertaken and s* = 30%.
No New Project
With New Project
H Firms 625 1250
L Firms 300 750
I did not tell you whether the firm was H or L.
Beliefs matter – as an investor, it matters what I believe is, given you offer me a project, the probability that you are H or L.
No New Project
New Project
H Firms 200 625
L Firms 50 375
Potential belief #1: Both firms undertake all projects.
Investors demand:• s* (0.5 x 625 + 0.5 x 375) = 300 s* =
60% Firms get:
• 40% of 625 = 250, if H undertake• 40% of 375 = 150, if L undertake
Beliefs work!
No New Project
New Project
H Firms 625 1250
L Firms 300 750
No New Project
New Project
H Firms 200 625
L Firms 50 375
Potential belief #2: Only L firms undertake projects.
Investors demand:• s* (375) = 300 s* = 80%
Firms get:• 20% of 625 = 125, if H do not undertake• 20% of 375 = 75, if L undertake
Beliefs work!
No New Project
New Project
H Firms 625 1250
L Firms 300 750
No New Project
New Project
H Firms 200 625
L Firms 50 375
No New Project
New Project
H Firms 200 625
L Firms 50 375
(related to the experiments replicated here)
If a unique equilibrium is predicted, it is observed.
If multiple equilibria are predicted, a pooling equilibrium is observed.
Note that it is a bit unclear whether we were acting in accordance with the pooling equilibrium in our Game 1. In our Game 2, the separating equilibrium share value was found in the second experiment (inconsistent with Cadsby et. al.results), but both firms entered the market. This is inconsistent with both the theory and the Cadsby et. al. results.
