Public Versus Private Debt: Confidentiality, Control, and Product Markets
31 Pages Posted: 27 Apr 2002
Date Written: January 22, 2001
We explore a firm's choice between public and private debt in a model where the firm's financing source affects its product market behavior. Debt can promote excessively risky product market strategies, but lender control through restrictive covenants - a characteristic of private debt - can commit the firm to reduce aggressiveness in product markets and increase expected profits (a monitoring effect). Private debt, however, reduces the information about a firm that competitors observe (a confidentiality effect). In our model, firms prefer to precommit to communicate idiosyncratic private information about costs, which they can do through public debt financing. Thus, the firm's choice between public and private debt depends on the tradeoff between the monitoring and confidentiality effects.
Keywords: product markets, disclosure, monitoring, choice of financing source
JEL Classification: G21, G32
Suggested Citation: Suggested Citation