Question

g According to the signaling theory of capital structure, a firm with favorable prospects should raise new capital by issuing ____ and a firm with unfavorable prospects raise new capital by issuing ____.

Answer 1

Answer:

The correct answer is letter "A": debt; equity.

Explanation:

Economists Franco Modigliani (1918-2003) y Merton Miller (1923-2000) in the signaling theory assume that investors and managers have the same information. Differences were caused as the result of companies issuing new stock when its price was overvalued or bonds when their price is undervalued.

Under that scenario, managers usually were confident in their firms' ability to generate capital. Then, they tended to issue new debt. However,  managers discouraged usually issued new equity in the form of stocks or bonds.