RISKY DEBT MATURITY CHOICE IN A SEQUENTIAL GAME EQUILIBRIUM

Jayant Raghunath Kale · Thomas H. Noe

165 citations0/0 files storedThe Journal of Financial Research

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Corporate Finance and Governance Corporate Insolvency and Governance Game Theory and Applications

Abstract

Abstract In this paper the choice of risky debt maturity structure is analyzed in a sequential game framework. The focus is on the set of viable equilibria when there are no transaction costs associated with the choice of debt maturity structure. It is shown that when changes in firm value are independent over time, both short‐ and long‐term debt pooling are Nash sequential equilibrium outcomes. However, only the short‐term debt pooling outcome satisfies the universal divinity refinement. Relaxing the assumption of independent changes in firm value, it is demonstrated that a separating equilibrium in which higher‐quality firms issue short‐term debt and low‐quality firms issue long‐term debt may exist. Furthermore, conditions exist under which long‐term debt pooling is the universally divine outcome.

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References

1987Signaling Games and Stable Equilibria 1986Asymmetric Information and Risky Debt Maturity Choice 1987Equilibrium Selection in Signaling Games

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