Testing Debt Signaling Hypothesis for Making Investment Decisions in Transitional Market : Evidence from Egypt

This paper examines the relationships between changes in firm's debt and its effects on firm's market value in a transitional market. The market value is considered as a measure of the investment worthiness. The signaling effect refers to the effects of debt on firm's market value.The paper examines the signaling effects of the determinants of capital structure that are relevant to a transitional market. These determinants cover the basics of tradeoff model, pecking order hypothesis and free cash flow hypothesis. The methodology begins with the determination of the relevant determinants of debt in a transitional economy. Next, the potential signaling effects of the relevant determinants of debt are examined. The robustness of the signaling effect is examined using the ‘Extreme Bound Analysis.' The overall results indicate that the worthiness of the investment (market value) is determined by interest rates (macro factor) and financial flexibility (firm-specific factor). These two factors have robust and significant signaling effects