Explanation

Asymmetric information is present in the real world and is a problem for managers and the firm if investors cannot see the true value of the firm due to a lack of information. Signals can help managers to provide clues for investors about how they view the firm. For example, the firm can pay higher dividends for the current year in order to give the impression to investors that the firm's current growth is sustainable in the future.

Sample Response

Asymmetric information occurs when the managers of a firm tend to have better information than the firm's investors. Signals can affect capital structure decisions by indirectly giving information to the company's investors about the firm's prospects.