Does Asymmetric Information Drive Capital Structure Decisions?

Using a novel information asymmetry index based on measures of adverse selection developed by the market microstructure literature, we test whether information asymmetry is an important determinant of capital structure decisions, as suggested by the pecking order theory. Our index relies exclusively on measures of the market's assessment of adverse selection risk rather than on ex ante firm characteristics. We find that information asymmetry does affect the capital structure decisions of U.S. firms over the sample period 1973--2002. Our findings are robust to controlling for conventional leverage factors (size, tangibility, Q ratio, profitability), the sources of firms' financing needs, and such firm…