The optimal debt structure : economic experimental analysis on the impact of liquidation policy and credit history

Abstract

With the rapid economic growth and raising demand for debt financing, debt structure has become an important concern in the financial market nowadays. Realizing this concern, our paper aims to use experimental tools to trace human behavior in the application of theoretical findings under Optimal Debt Structure framework. By closely monitoring and analyzing the experimental data obtained in 3 separate treatments, we find the optimal liquidation probability acceptable by both debtors and creditors in general is consistent with the theoretical predictions. Moreover, comparison across treatments suggests that liquidation policy functions as an effective tool in deterring strategic defaults and firm credit history gives further incentive to honest behaviors. With this study, we hope to provide supplement to the existing theoretical studies in Optimal Debt Structure and bring out possible deviations arising from human behavioural considerations in real life applications.