Tests of a Signaling Hypothesis: The Choice between Fixed- and Adjustable-Rate Debt.

We develop a model wherein the choice between adjustable- and fixed-rate debt can serve as a signal of firm quality. The nature of the signal depends on expected inflation volatility relative to other risk parameters. Evidence from a matched sample of debt announcements over the period 1978 to 1986 shows a difference of [minus]2.05 percent between stock price reactions to adjustable rate and fixed rate announcements when expected inflation volatility is above an estimated threshold. Below this threshold, the difference is [plus]0.98 percent. The evidence supports the hypothesis that the riskier debt choice serves as a favorable signal of firm quality. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.