Information Asymmetry and Debt–Equity Choice: Evidence from an Emerging Market, India

Abstract

We examine the role of information asymmetry in the debt-equity choice decisions of firms from an important emerging market, India. Information problems are more severe in the emerging markets and we find strong evidence in favour of information asymmetry playing a key role in the capital structure decisions of Indian firms. Consistent with the pecking order model, we find that equity issues are lesser in number and firms facing fewer information problems issue equity. We use novel variables such as analyst coverage, analyst forecast surprise and dispersion to capture information asymmetry in the Indian market.

Choice between rights issue and private placements of equity and the role of information asymmetry

“…Prevalence of widespread information asymmetry has made emerging markets an ideal setting for testing security issue decisions (Sony and Bhaduri, 2018). The next section throws some insights into the equity markets in India, one of the most important emerging economies.…”

“…Therefore, firms have incentives to choose debt securities over equity when faced with information problems. Though the empirical evidence favoring the hierarchical pattern varies across economies and times, the role of information asymmetry as a key determinant of the security issue decision is widely accepted (Sony and Bhaduri, 2018; Gao and Zhu, 2015; Leary and Roberts, 2010; Bharat et al. , 2009; Chang et al.…”

“…Several studies have examined these security issue decisions of Indian firms, and information asymmetry emerges as one of the key factors limiting the equity issues (Sony and Bhaduri, 2018; Bhaduri, 2015). It is often argued that information asymmetry is deep-rooted in Indian capital markets due to the widespread market imperfections, poor legal and institutional systems, lack of solid redressal mechanism for common investors and inadequate information disclosure mechanisms (Sarkar and Sarkar, 2012).…”

“…Moreover, empirical evidence also points out the prevalence of information asymmetry in the Indian markets (Sarkar and Sarkar, 2012). Importantly, Sony and Bhaduri (2018) and Bhaduri (2015) argue that information asymmetry is a key determinant of capital structure decisions of Indian firms. Therefore, India turns out to be the right setting to examine the impact of information asymmetry.…”

“…The research reports published by analysts provide more information to the investors and the public, thereby alleviating information asymmetry. Therefore, using analyst-coverage-related variables overcomes the problems of conventional variables and turns out to be a better proxy for capturing information asymmetry (Sony and Bhaduri, 2018; Gomes and Phllips, 2012; Chang et al. , 2006).…”