One Approximation of the Real-World Corporate Financing Decisions

This paper is the first attempt to reconcile the prospect theory and the contract theory in explaining the observed financing decisions. In a world of ambitious and aggressive economic agents, even the original equilibria under the presence of asymmetric information break down. When the aggressiveness in the market is prevailing, there exist multi-pooling-equilibria, which might help explain why the academic can not find the optimal leverage. In the meanwhile, debt issuance would be lower, which shed light on the distinct liquidity provision patterns between bull and bear market. Firm with lottery-like investment opportunity will more easily get external financing than that with safe project, as both market participants, entrepreneur and financier, perceive the project more valuable than the value would otherwise be suggested by the classical expected utility theory