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TheSocietyforFinancialStudiesCapitalStructureandDividendIrrelevancewithAsymmetricInformationAuthor(s):PhilipH.DybvigandJaimeF.ZenderSource:TheReviewofFinancialStudies,Vol.4,No.1(1991),pp.201-219Publishedby:OxfordUniversityPress.Sponsor:TheSocietyforFinancialStudies.StableURL::06/01/201106:10YouruseoftheJSTORarchiveindicatesyouracceptanceofJSTOR'sTermsandConditionsofUse,availableat.://=oup..EachcopyofanypartofaJSTORtransmissionmustcontainthesamecopyrightnoticethatappearsonthescreenorprintedpageofsuchtransmission.JSTORisanot-for-profitservicethathelpsscholars,researchers,andstudentsdiscover,use,andbuilduponawiderangeofcontentinatrusteddigitalarchive.Weuseinformationtechnologyandtoolstoincreaseproductivityandfacilitatenewformsofscholarship.FormoreinformationaboutJSTOR,pleasecontactsupport@jstor.org.OxfordUniversityPressandTheSocietyforFinancialStudiesarecollaboratingwithJSTORtodigitize,preserveandextendaccesstoTheReviewofFinancialStudies.(1958,1963;MillerandModigliani,1961)irrelevancypropositionsimplythatcapitalstructureanddividendpolicyaremattersofirrelevanceintheabsenceoftransactioncosts,taxes,andinformationalasymmetries.Iftheirrelevancypropositionsaccuratelyexplaintheworld,thenwecannothopetodevelopanymodelthatcanpredictAnearlierversionofthisarticleappearedasachapterofZender'sPh.D.thesis[Zender(1988)].DybvigisgratefulforsupportundertheSloanResearchFellowshipprogram.WearegratefulforhelpfulcommentsfromJeffBorland,JoelDemski,DougDiamond,ThomasGeorge,JonIngersoll,SamanMajid,MertonMiller,SteveRoss,ChesterSpatt,andmanyseminarparticipantsatdifferentschools.AddressreprintrequeststoPhilipH.Dybvig,OlinSchoolofBusiness,WashingtonUniversity,CampusBox1133,St.Louis,MO63130.TheReviewofFinancialStudies1991Volume4,number1,pp.201-219?1991TheReviewofFinancialStudies0893-9454/91/$1.50TheReviewofFinancialStudies/v4n11991orprescribecapitalstructureordividendpolicy.Moreinterestingly,irrelevancypropositionsindicatewherenottolookforpredictiveandprescriptivemodels.Furthermore,irrelevancypropositionsprovideaframeworkforclassifyingdifferentpotentialmodelsinwhichcapitalstructureordividendpolicyisrelevant,basedonhowtheassumptionsoftheirrelevancypropositionshavebeenviolated.Forthesereasons,theirrelevancypropositionshavebeenthebenchmarkagainstwhichmodelsofcapitalstructureanddividendpolicyhavebeenevaluated.Thepurposeofthisarticleistoextendtheirrelevancypropositionstoalargeclassofmodelswithasymmetricinformation.Theirrelevancypropositionsinthisarticlemayseemtobelogicallyinconsistentwithanumberofarticlespresentingmodelsinwhichasymmetricinformationdoesmakecapitalstructureordividendpol-icymatter.1Themaindifferencebetweenthisarticleandmostoftheexistingliteratureisinthemanager'sassumedincentives:whilewedeterminethemanager'sincentivesasanoptimalchoice,mostarti-clesintheliteratureassumesuboptimalincentives.Someofthesearticlesalsoassumeimplicitlythatitisusefulformanagerstosignalinformationaboutthefirmtothemarket.Infact,iftheinformationpossessedbymanagersisfirm-specific,thisimplicitassumptionisprobablyincorrect.2ThestartingpointforouranalysisisMyersandMajluf(1984),adistinguishedrepresentativeoftheliteraturewearecriticizing.MyersandMajlufconsiderseveralsuboptimalobjectivesformanagers,butwewillfocusontheirleadingcaseofamanagerwhoisassumedtoactonbehalfofexistingshareholderswhoholdtheirinvestmentuntiltheend,whenthefirmisliquidated.Whilethismaysoundlikeareasonablemanagerialobjective,MyersandMajlufdemonstratethatitimpliessuboptimalinvestment.Specifically,supposethattheman-agerhasprivateinformationaboutexistingassetsandaboutapoten-tialnewproject.Amanagerwhoobservesverygoodnewsabouttheexistingprojectswouldrefrainfromtakingonanewprojectthatisonlymodestlyprofitable,becauseastockofferingatapricebased'SomeexamplesofimportantarticlesinthisliteratureareBhattacharya(1980)