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A friend of yours explains that she looks for signals in the capital structure decisions that...

A friend of yours explains that she looks for signals in the capital structure decisions that firms make, believing that asymmetric information exists and that investors can learn things about firms by studying their financing decisions. What does she mean by this? What might be an example of something she thinks she can learn by studying firm decisions such as these?

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Change in the capital structure decision of a firm could be an indicator of asymmetric information. This implies that the managers of the firm could be having more information than the investors and the capital structure decisions made by the management is a hint of additional information about the operations and future prospects of the business.

An instance of asymmetric information signalled due to change in capital structure decisions could be when a company issues new stock. This indicates that the company was in need of funds but due to unstable earnings they decided to raise finance through issuing stock rather than taking debt. This is more so the case because cost of equity is higher than the cost of debt. Another instance arises when a company takes on more debt. This indicates that the management is assured of stable earnings to service the liabilities taken.

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