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On signalling and debt maturity choice

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  • Lensink, Robert
  • Pham Thi Thu, Tra

    (Groningen University)

Abstract

The theoretical literature on a firm?s choice of debt maturity argues that a borrowing firm can signal its value in asymmetric information setting by borrowing short. This well-known fact is based on Flannery (1986). This paper questions the use of debt maturity as a signalling device. We demonstrate that Flannery?s (1986) signalling outcome is vulnerable on two accounts. First, the separating equilibrium established by Flannery is not driven by the incentive compatibility. Second, derivations of the separating equilibrium appear to be vulnerable due to the lack of the refinements of pooling equilibria. If correct constraints are provided, the parameter space for the separating equilibrium shrinks, moderating the signalling role of debt maturity.

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File URL: http://irs.ub.rug.nl/ppn/294685839
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Paper provided by University of Groningen, Research Institute SOM (Systems, Organisations and Management) in its series Research Report with number 06E03.

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Date of creation: 2006
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Handle: RePEc:dgr:rugsom:06e03

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  1. Allen N. Berger & Marco A. Espinosa-Vega & W. Scott Frame & Nathan H. Miller, 2004. "Debt maturity, risk, and asymmetric information," Working Paper 2004-32, Federal Reserve Bank of Atlanta.
  2. Mathias Dewatripont & Patrick Bolton, 2005. "Contract theory," ULB Institutional Repository 2013/9543, ULB -- Universite Libre de Bruxelles.
  3. Flannery, Mark J, 1986. " Asymmetric Information and Risky Debt Maturity Choice," Journal of Finance, American Finance Association, vol. 41(1), pages 19-37, March.
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