SMEs investment and financing under asymmetric information

Wang, Yao and Zhang, Hai and Zhao, Zhiming (2019) SMEs investment and financing under asymmetric information. Working paper. University of Strathclyde, Glasgow.

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Abstract

We consider investment timing and financing decisions for finance constraint small and medium-sized enterprises (SMEs) in a dynamic setting with asymmetric information. To effectively alleviate the borne financial constraint, SMEs finances a risky project with the help of innovative contract, equity-for-guarantee swap (EGS), within which it secures guaranteed debt at the expense of equity dilution to an outside insurer. We show that firms with high cash flow can credibly signal their type to outsider insurers using the timing of investment and offering guarantee compensation package as well. In addition, asymmetric information indeed induces high-type firms speed up investment, leads to higher guarantee costs. Our findings support that EGS not only mitigates financing constraints but also reduces investment distortion for SMEs under information asymmetry. Finally, our model generates testable implications with respect to SMEs investment and financing decisions.