Effects of asymmetric information on agricultural borrowing, investment, and capital structure

This study examined optimal farm capital structure and investment under asymmetric information between the farm borrower and lender. The capital structure of the borrower may affect the terms of the loan contract or may restrict credit availability. Thus, under asymmetric information conditions, the capital structure and investment decisions of the farmer are related via non-price conditions of loans.;The optimal farm capital structure model of Barry, Baker and Sanint was augmented to account for the effects of asymmetric information and the interaction between farm investment and capital structure was empirically modeled. For the empirical analysis, a "pecking order hypothesis" for capital structure was specified to model farm incentives to manage capital structure under asymmetric information and a neoclassical q theory that accounts for the lack of a perfect capital market was employed to model investment behavior.;The farm capital structure model of Barry, Baker, Sanint was augmented by adding asymmetric information costs borne by the borrower and a non-price. Comparative statics indicated that the farm debt to equity ratio would decrease with increases in: the rate of cost due to asymmetric information; the variance of the rate of cost of debt due to asymmetric information; and the marginal cost of the non-price credit restriction.;Annual investments and capital structure were examined in the second analysis by specifying an investment and capital structure equation to capture the effects of asymmetric information. The joint specification is tested using an agricultural sector data set covering the period 1960-91 and a panel of Illinois grain farmers over the period 1986-92.;The results of the sector model indicated that the addition of debt can be both beneficial and harmful. The results indicate that a non-price restriction was in effect. The pecking order relationship was found to hold in the second capital structure equation. In the farm level analysis, the investment equation supported the q-like specification, but was not constrained by farm solvency. The pecking order relationship was found to hold in the second capital structure equation. Thus, farm investment behavior and capital structure decisions were jointly determined.