Strategic Role of Debt in Duopoly with Incomplete Information

This paper investigates the strategic role of debt in a duopoly in which firms eventually have to leave the market. The market is charac-terized by incomplete information. Comparing the benchmark model without debt to the one with debt, we argue that debt can be used as a signal to induce the competitor to leave the market earlier than it otherwise would. We specify the conditions under which debt has a signaling value and the debt contract that achieves it. We find that debt has signaling value when (lack of) exercise of options does not convey any information.