How do companies decide in practice which route to follow in raising capital? The decision is complex and related to a company's balance sheet, market conditions, outstanding obligations and a host of other factors. Discuss the various factors and theories one should keep in mind while taking these decisions.
1. Market signaling
There is something special or unique about bank loans that make some borrowers willing to pay higher interest rates than those on other securities of equivalent risk. Bank loans are inside debts where the lender obtains information about the firm not available publicly. Since, bank loan is a low-priority claim, periodic signals from short-term bank loans about an organization's credit worthiness lower the information costs of other agents in the organization. Renewal of bank loan sends a signal to the bondholders and equity market that the firm is financially sound. This is used as a cheapest source of information delivery as directly communicating with large number of shareholders or bondholders is not feasible. Other signals such as high ...
This post discusses various factors and theories which one should keep in mind while taking decisions to raise fresh capital from the capital market (Approx 500 words). Some of the concepts discussed are signaling theory, pecking order theory, business networks, insider holding, etc. This solution is 473 words.