Equity, bonds, and bank debt: Capital structure and financial market equilibrium under asymmetric information

This paper proposes a model of financial markets and corporate finance, wit h asymmetric information and no taxes, where equity issues, bank debt, and bund financing coexist in equilibrium. The relationship banking aspect of f inancial intermediation is emphasized firms turn to banks as a source of in vestment mainly because banks are good at helping them through times of fin ancial distress. This financial flexibility is costly since banks face cost s of capital themselves (which they attempt to minimize through securitizat ion). To avoid this intermediation cost, firms may turn to bond or equity f inancing, but bonds imply an inefficient liquidation cast and equity an inf ormational dilution cost. We show that in equilibrium the riskier firms pre fer bank loans, the safer ones tap the bond markets, and the ones in betwee n prefer to issue both equity, and bonds. This segmentation is broadly cons istent with stylized facts.