SME investment and financing under asymmetric information

Event Date: 3 February 2021

Speaker: Hai Zhang

Time: 2pm

Abstract

We consider the investment timing and financing decisions of financially constrained small and medium-sized enterprises (SMEs) in a dynamic setting with asymmetric information. To alleviate its financing constraints, an SME finances a risky project using equity-for-guarantee swaps (EGS), which secures guaranteed debt—at the expense of equity dilution in favor of an external insurer. We show that firms with high cash flow can credibly signal their type to external insurers by using the timing of investment and by offering a guarantee compensation package. Further, asymmetric information induces high-type firms to speed up investment, leading to higher guarantee costs. Our findings support that EGS not only mitigates financing constraints but also reduces investment distortion for SMEs under information asymmetry. Finally, our model generates testable implications with respect to SME investment and financing decisions under information asymmetry 

Published: 10 March 2021