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Rev Fin 1995; 8:605-636
© 1995 the Society for Financial Studies

Article

Tests of a signaling hypothesis: the choice between fixed-and adjustable-rate debt

J Guedes and R Thompson
Cox School of Business, Southern Methodist University, Dallas, TX 75275, USA

Abstract

We develop a model wherein the choice between adjustable- and fixed-rate debt can serve as a signal of firm quality. The nature of the signal depends on expected inflation volatility relative to other risk parameters. Evidence from a matched sample of debt announcements over the period 1978 to 1986 shows a difference of -2.05 percent between stock price reactions to adjustable rate and fixed rate announcements when expected inflation volatility is above an estimated threshold. Below this threshold, the difference is +0.98 percent. The evidence supports the hypothesis that the riskier debt choice serves as a favorable signal or firm quality.


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