If you know that your firm is facing relatively poor prospects but needs new capital,and you know that investors do not have this information,signaling theory would predict that you would
A) Issue debt to maintain the returns of equity holders.
B) Issue equity to share the burden of decreased equity returns between old and new shareholders.
C) Be indifferent between issuing debt and equity.
D) Postpone going into capital markets until your firm's prospects improve.
E) Convey your inside information to investors using the media to eliminate the information asymmetry.

Question

Quizplus · Accepted Answer

Signaling theory suggests that a firm facing poor prospects should issue equity rather than debt to avoid the appearance of distress. By issuing equity, the burden of decreased equity returns is shared between old and new shareholders, and this signals confidence in the firm's prospects to potential investors.

If You Know That Your Firm Is Facing Relatively Poor