Essays on Financial Economics


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Virginia Tech


This dissertation consists of three papers. In the first paper, I study firms' capital raising decisions in a two-stage signaling game. In the model, firms can issue debt or equity to finance sequentially arriving investment projects. Management is assumed to have an initial information advantage over investors. However, when a firm's decision in the first stage can change investors' beliefs and, consequently, impact the security issuance in the second stage, its optimal choice differs significantly from the strict debt-equity preference in a comparable one-stage model. In equilibrium, a dynamic pecking order arises, suggesting that the information friction can solely explain various aspects of observed corporate financing behavior.

The second paper is coauthored with Hans Haller. In this paper, we model how different wealth constraints among investors affect an entrepreneur's way of raising capital, his share of project NPV, and his ownership of the new firm. Combining cooperative and noncooperative approaches, we develop and analyze a bargaining framework and demonstrate cases in which a fair division cannot be achieved when sharing of cost and sharing of return are jointly considered. Our results cover conditions on how the entrepreneur can strategically achieve larger net wealth accumulation, and when he can obtain control of the firm. We further discuss the entrepreneur's preferences on the firm's ownership dispersion level under public financing.

The third paper argues that although innovation is costlier than imitation, the incumbent firm is endowed with an advantage of enhancing its product ahead of potential competitors. In a model that connects consumers' utility with firms' production, I show that the incumbent's product enhancement decision can foster the creation of a better product, improve consumers' utility, and deter entrance from competitors. The pace of creative activities is determined by the incumbent's potential of improving its product quality and the nature of product differentiation in the industry. Thus, creative destruction may not manifest itself as new firms replacing the incumbent, but as the incumbent constantly renovating its product.



Capital Structure, Dynamic Signaling Game, Adverse Selection, Ownership and Control, Wealth Constraint, Bargaining, Shapley Value, Innovation, Product Enhancement, Entry Deterrence, Creative Destruction