Public Versus Private Debt: Confidentiality, Control, and Product Markets

31 Pages Posted: 27 Apr 2002

See all articles by Alexander W. Butler

Alexander W. Butler

Rice University - Jesse H. Jones Graduate School of Business

Mitchell Berlin

Federal Reserve Bank of Philadelphia - Research Department

Date Written: January 22, 2001

Abstract

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

Butler, Alexander W. and Berlin, Mitchell, Public Versus Private Debt: Confidentiality, Control, and Product Markets (January 22, 2001). Available at SSRN: https://ssrn.com/abstract=307087 or http://dx.doi.org/10.2139/ssrn.307087

Alexander W. Butler (Contact Author)

Rice University - Jesse H. Jones Graduate School of Business ( email )

MS 531
Houston, TX 77005
United States
713-348-6341 (Phone)

HOME PAGE: http://www.owlnet.rice.edu/~awbutler/

Mitchell Berlin

Federal Reserve Bank of Philadelphia - Research Department ( email )

Ten Independence Mall
Philadelphia, PA 19106-1574
215-574-3822 (Phone)
215-574-4364 (Fax)

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