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The Choice of Debt Contracts
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accepts the offer borrower borrower's capital structure cash flows debt financing demand repayment entrenched manager financing decision Firm makes offer incentive compatible increased flexibility investment in value-decreasing investment in value-enhancing issue public debt junk bonds last term lender accepts lender is informed lender receives Lender rejects offer liquidate the firm liquidation value Liquidity risk long-term debt contract long-term private debt losing its private loss of private management chooses management invests management prefers management to invest management's private benefits Manager complies marginal maturity Nash equilibrium offer and audit old assets order conditions payoff private benefits worth private debt contract private debt restrictions private gains probability of value-enhancing project is value-decreasing project is value-enhancing rejects any offer rejects the offer restrict investment restrictive covenants risk is low selectively relaxed short-term debt contract short-term private debt stringent covenant restrictions type of debt Uninformed Lender value-decreasing projects value-enhancing new projects value-enhancing projects increase