A Game-Theory View of Capital Structure

Abstract

If firms have optimum debt ratios (or 'targets'), when given choice we expect them to move towards these optimums. For Asia-pacific countries publicly-traded firms' profitability, size, growth, and share price are not significant determinants of capital structure changes as would be expected in a wealth maximization approach to management. Firms with 'more choice' do not change debt levels any more than those with 'less choice'. Looking to game theory we suggest that capital structure of publicly listed firms is stuck in a sub optimal Nash equilibrium. Firms do not actively follow either static-trade off theory or the pecking order hypothesis. When given choice firms do not move towards an optimum and they do not always adopt capital structures with the value maximising level of debt. In this non cooperative market, leverage is required to protect against takeovers and maintain corporate control.