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.
|Published - 2006