Abstract

Financial markets reveal information through which firm managers increase the value of equity, e.g., by improving investment decisions. With debt, however, such decisions are not necessarily socially efficient. We demonstrate that investors’ endogenous information acquisition, acting through this feedback channel, attenuates risk-shifting but amplifies debt overhang. The most ex-ante inefficient examples of risk-shifting encourage information acquisition, lowering the likelihood such projects are chosen inefficiently ex-post. The logic reverses with debt overhang: more efficient projects discourage information acquisition, increasing the ex-post likelihood they are foregone. Our model provides a novel channel through which financial markets impact agency frictions between firm stakeholders.

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• Keyword(s):
• finance 247
• investments 83

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