Yet the difference between holy books and money is far smaller than it might seem. When most people see a dollar bill, they forget that it is just a human convention. As they see the green piece of paper with the picture of the dead white man, they see it as something valuable in and of itself. They hardly ever remind themselves, “Actually, this is a worthless piece of paper, but because other people view it as valuable, I can make use of it.” If you observed a human brain in an fMRI scanner, you would see that as someone is presented with a suitcase full of hundred-dollar bills, the parts of the brain that start buzzing with excitement are not the skeptical parts but the greedy parts. Conversely, in the vast majority of cases people begin to sanctify the Bible or the Vedas only after long and repeated exposure to others who view it as sacred. We learn to respect holy books in exactly the same way we learn to respect paper currency.
Bill Fulkerson on 05 Oct 20We study the classical problem of raising capital under asymmetric information. Following Myers and Majluf, we consider firms endowed with assets in place and riskier growth opportunities. When asymmetric information is concentrated on assets in place (rather than growth opportunities), equity-like securities are more likely to be optimal. In contrast, when asymmetric information falls on growth options, debt is optimal. Intuitively, this happens because when the asset with greater volatility is less affected by asymmetric information, issuing a security with greater exposure to upside potential (such as equity) can be less dilutive than issuing a security lacking such exposure (such as debt). Our results suggest that equity is more likely to dominate debt for younger firms with larger investment needs, endowed with riskier, more valuable growth opportunities. Thus, our model can explain why high-growth firms may prefer equity over debt, and then switch to debt financing as they mature.
