Corporate financing and investment decisions when firms have information that investors do not have¶
Why this mattered¶
Myers and Majluf gave corporate finance a rigorous model of how asymmetric information can shape financing and investment choices. Before this paper, capital structure was often framed around taxes, bankruptcy costs, or agency problems. Their contribution was to show that even value-maximizing managers, acting in existing shareholders’ interests, may rationally pass up positive-net-present-value projects if financing them requires issuing equity at a price that uninformed investors would interpret as overvalued. The result made “underinvestment” possible without managerial incompetence or market irrationality: it could arise from the informational structure of securities markets itself.
The paper’s central insight became the foundation of the pecking order theory of financing. If outside investors cannot perfectly observe firm value, managers prefer internal funds first, then relatively safe debt, and equity only as a last resort, because equity issuance is most exposed to adverse-selection discounts. This shifted empirical and theoretical work away from searching for a single optimal debt ratio and toward studying financing as a sequence of choices conditioned by information, market timing, and security design.
Its influence extended well beyond capital-structure theory. The model helped explain why equity issues often produce negative stock-price reactions, why cash holdings and financial slack can preserve investment capacity, and why firms may design securities to reduce informational sensitivity. Later work on security issuance, market timing, payout policy, cash management, and contracting repeatedly built on the Myers-Majluf mechanism: financing decisions are not just ways to fund investment, but signals and constraints created by unequal information between insiders and outside capital markets.
Abstract¶
(no abstract available)
Related¶
- cite → Credit Rationing in Markets with Imperfect Information — Myers and Majluf cite credit rationing as a related asymmetric-information result showing how hidden borrower quality distorts financing markets.
- cite → Determinants of corporate borrowing — Myers and Majluf cite Miller's corporate borrowing theory as prior capital-structure work on debt financing incentives.
- cite → The Market for "Lemons": Quality Uncertainty and the Market Mechanism — Myers and Majluf cite Akerlof's lemons model as the core adverse-selection mechanism behind undervalued equity issuance.
- cite → Theory of the firm: Managerial behavior, agency costs and ownership structure — Myers and Majluf build on Jensen and Meckling's agency-cost view of firm financing by showing how asymmetric information between managers and outside investors distorts investment and capital-structure choices.
- enables ← Determinants of corporate borrowing — Static tradeoff ideas about debt determinants framed the capital-structure benchmark that Myers and Majluf contrasted with information-driven financing choices.
- enables ← The Market for "Lemons": Quality Uncertainty and the Market Mechanism — Akerlof's adverse selection mechanism under asymmetric information underlies Myers and Majluf's pecking-order model of corporate financing.
- enables ← Theory of the firm: Managerial behavior, agency costs and ownership structure — Agency-cost theory linked ownership and financing conflicts, motivating Myers and Majluf's analysis of investment decisions under managerial private information.