Information Revelation and Strategic Use of Capital Structure in Duopoly with Asymmetric Information

This paper studies strategic behavior in product markets with asymmetric information. A real options model is developed to investigate information revelation and signaling role capital structure. Information revelation is ensured through a learning mechanism that stems from the real options framework: firms learn from the strategic exercise of options. In cases where option exercise fails to yield information, firms issue securities in order to change the strategic behavior of their competitors. Such a policy, in turn, is shown to impose constraints on the ex ante capital structure decision of the firm. The outcome of competition depends on industry and firm characteristics. The model has important implications for firms operating in mature industries with low growth and/or high operating expenses