Essays on Investment and Financing Decisions

This dissertation contains three essays in the area of Business Finance which are related to the literature of asymmetric information and agency. Our purpose is to demonstrate that the presence of asymmetric information creates possible costly effects that adversely influence the performance and profitability of the firm.

The first essay deals with the value of slack (excess liquidity) and the investment decision under asymmetric information. It is shown that when managers and shareholders hold different information sets with respect to the quality of an investment opportunity, an optimum amount of slack can partially resolve an underinvestment problem. The employed framework emphasizes the existence of a penalty function which is assigned by capital market participants due to the uncertainty associated with the announcement of external financing.

In the second essay, we address issues of risk sharing between an agent and a principal. We examine the principal-agent relationship under the plausible condition of a multidivisional managerial effort. It is suggested that under realistic assumptions, information about the divisional performance produces sharing rules which are different from those derived under the condition of aggregated information.

The third essay deals with issues of agency costs and financial decisions at the divisional level of a multidivisional firm. It is argued that the internal organizational structure places some constraints on the nature of the financial decisions made by the division manager. The internal regulatory environment forces the divisional manager to be risk averse and to avoid the adoption of risky projects. The costs associated with this managerial behavior, called managerial regulatory costs, represent a different dimension of agency costs.