Conflict of Interest, Bond Rating and the Value Maximization Rule
A number of authors have noted that when a firm issues risky debt in the absence of binding state-contingent contracts, the maximize-present-value rule becomes ambiguous. This paper shows that incomplete (asymmetric) information can explain why the firm will make value-maximizing decisions when there is a conflict of interest between shareholders and bondholders. The reputation effect of D. M. Kreps and R. Wilson (1982) and its implications for the pricing of securities is at the heart of this explanation. Copyright 1987 by The Review of Economic Studies Limited.
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Volume (Year): 54 (1987)
Issue (Month): 216 (November)
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