Summary
This is an extension of article published by Younis, Kisa, and Howard in the Researcher, July 2006, entitled "Implications of Informational Asymmetry and Principal-Agent Relationship". In this article the authors will cover the comprehensive review of seminal works for Miller and Rock (1985) and Myers and Majluf (1984), accompanied by a series of short reviews of related empirical studies.
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Extract
A Review of Implications of Informational Asymmetry and Principal-Agent Relationship
THEORETICAL MODELS
A. Miller and Rock (1985)If we replace symmetric information assumption of standard finance model of the firm's dividend /investment/finance decision with the more plausible one that managers know more than outside investors about the true state of the firm's current earnings, in a world or rational expectations, the firm's dividend (or financing) announcements provide information about the unobserved firm's current earnings. However, incentives for managers whose compensations are tied directly or indirectly to the firm's short-run price performance, may induce them to pay out more dividends than the market is expecting, even if that means cutting back on investment. On the other hand, if we introduce trading of shares in the system, even though the market will eventually adjust the price, that eventual restoration will be of little concern to those shareholders who have managed to sell out at the inflated post announcement price. In such a case, Fisherian Criterion for optimal investment by the firm that states that the firm should invest in real assets until the marginal internal rate of return equal the appropriately risk-adjusted rate of return on securities fails to hold.The paper investigates the effects of departing from the optimum investment policy on both sellers and stayers and show that the potential gain to the sellers w...See the full content of this document
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