Corporate Finance Multidimensional Signaling Games: Theory and Evidence

Abstract

The research question of this dissertation concerns the interaction between multiple corporate finance signaling devices and multidimensional private information. First, while traditional corporate finance theories and empirical works are concerned with the question of whether an activity serves as a signaling device, I provide an analytical tool for answering a more subtle question: To what extent does an activity serve as such a device? In order to answer this question, this study introduces a novel concept: the contribution of a signaling device to the informativeness of equilibrium - where informativeness is the degree to which the market can differentiate between firms. Second, this study examines an additional channel of indirect signaling, where one device conveys information regarding the marginal rate of substitution of a second device. This framework leads to new theoretical insights, for example, the notion that an activity may serve as a signaling device, even if its costs are positively correlated with firm quality. I provide novel empirical evidence, regarding the signaling interaction of two long-debated practices - open market stock repurchases and insider trading. Consistent with my empirical predictions, I find evidence that (a) the market reaction to share repurchases depends on the amount of information conveyed by changes in mangers’ holdings, (b) future operating performance is quasi-concave in managers’ net purchases and firms’ actual repurchases, (c) non-monotonicity of share repurchases in future operating performance (d) share repurchases are followed by increase in firm risk and (e) when accompanied with share repurchases, managers’ holdings increase with future firm risk.