Question

Asymetric Information -

(A) Suppose that anytime corporate insiders believe that their company's stock is selling for more than its true value they take advantage of this and sell additional stock to the public. How should the market react to the announcement that the firms about to sell additional stock? That is, should this announcement increase or decrease the price of the company's stock?

Bankruptcy Cost -

(B) As part of the bailout of General Motors, the government's orchestrated bankruptcy proceedings paid bondholders much less on their debt so that autoworker unions could protect more jobs. This was highly applauded by union activists, but what will likely happen the next time General Motors tries to issue bonds to the public? Specifically, what effect will this have on GM's cost of debt?

Answer 1

(A) Generally whenever there is additional offloading or selling of shares of a company by the management, without any specific reason, the market takes it adversely. The investors feel that whenever the company sells additional shares, it might be expanding to raise capital, which if not necessarily announced, investors understnd that there is something going on in the company which is negative to the share value. So the market in general reacts adversely and share value falls.

The share price might increase a little post announcement but it then falls down as market generally does not consider it a good sign.

(B) General Motor's has lost its credibility of repaying its bond holder's appropriately once it faltered after filing for banckruptcy. Thus raising money through bonds would be highly disliked by investors and its cost of debt would also be high. The company would have to pay a higher lucrative coupon rate in order to attract investors since it's history is laden with faltered credibility.