A Word on Game Theory Application to Corporate Finance

Finance in general is concerned with how the savings of investors are allocated through financial markets and intermediaries to firms, who use them to fund their activities. Finance can broadly be broken down into two fields. The first is asset pricing, which is concerned with the decisions of investors. The second is corporate finance, which is concerned with the decisions of firms. This paper will focus on the latter field and how game theory can be used to explain certain behaviors that are regularly witnessed. 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 will show how different game theory models can be used to more accurately explain observed financial decisions dealing with capital structure, corporate acquisitions and initial public offerings (IPOs).