How applications of game theory can be used to explain various observed phenomena in corporate finance.
Written in 2002; 1,955 words; 7 sources; MLA; $ 62.95
Paper Summary:
This paper explains that traditional financial thinking relies on assumptions of certainty, complete knowledge and market efficiency and in this context, financial decisions should be relatively straightforward. In the real world though, many times what is observed deviates greatly from what would be expected using traditional financial thinking. This paper therefore uses different game theory models to more accurately explain observed financial decisions dealing with capital structure, corporate acquisitions and initial public offerings (IPOs).
From the Paper:
"Game theory has made great strides in explaining many of the observed phenomena falling under corporate finance. One example is the capital structure decided upon by a firm's management. Capital structure deals with the firm's decision to raise funds through debt versus equity and what ratio of debt to equity should the firm maintain. Modigliani and Miller in 1958 showed that in perfect capital markets (i.e. no frictions and symmetric information) and no taxes a firm could not change its total value by altering its debt/equity ratio; thus capital structure is irrelevant. However in the real world, capital structure is carefully thought about by every company, and it is in fact not irrelevant because taxes do exist and capital markets are not perfect."
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