RISKY DEBT MATURITY CHOICE IN A SEQUENTIAL GAME EQUILIBRIUM

TLDR

The paper analyzes how firms choose risky debt maturities within a sequential game framework. The study examines the set of viable equilibria when debt maturity choice incurs no transaction costs. When firm value changes are independent, both short‑ and long‑term debt pooling are Nash equilibria, but only short‑term pooling meets the universal divinity refinement; if independence is relaxed, a separating equilibrium can arise with high‑quality firms issuing short‑term debt and low‑quality firms issuing long‑term debt, and under certain conditions long‑term pooling can also be universally divine.

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.