Capital Structure with Countervailing Incentives

Abstract

The regulatedjirm's choice of capital structure is affected by countervailing incentives: the jirm wishes to signal high value to capital markets to boost its market value while also signalling high cost to regulators to induce rate increases. When the jim's investment is large, countervailing incentives lead both high- and low-cost jims to choose the same capital structure in equilibrium, thus decoupling capital structure from private information. When investment is small or medium-sized, the model may admit separating equilibria in which high-cost jirrns issue greater equity and low-cost jims rely more on debt jinancing.