Financial Policy and Reputation for Product Quality

The effect of financial policy on a firm's incentives to maintain its reputation for producing a high-quality product is analyzed. It is demonstrated that in certain situations debt will reduce a firm's ability to credibly offer high-quality products and, as a consequence, will reduce its value. However, for firms with assets that have high salvage values in liquidation, debt may increase their ability to credibly offer high-quality products and, therefore, increase their values. Article published by Oxford University Press on behalf of the Society for Financial Studies in its journal, The Review of Financial Studies.