Asymmetric Information and Debt Financing: Hie Empirical Importance of Size and Balance Sheet Factors

In an environment with asymmetric information regarding the outcome of investment activities, the premium on external funds is dependent upon a borrower's financial characteristics. Consequently, a borrower's need for funds and accessibility to the desired amount is interlinked. Using panel data over the 1970-89 period, this study finds that a firm's existing level of indebtedness reduces its current net issuance of long term debt. Bigger firm size, higher net worth and a lower sales to asset ratio alleviate this negative effect. The results suggest that the notion of a stronger balance sheet, which governs a firm's access to the capital market, should be extended to include the non-financial sales to asset ratio variable.