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Capital structure, investment, and fire sales

Gale, Douglas and Gottardi, Piero (2014) Capital structure, investment, and fire sales. SRC Discussion Paper (No 23). Systemic Risk Centre, The London School of Economics and Political Science, London, UK.

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Abstract

We study a dynamic general equilibrium model in which firms choose their investment level and their capital structure, trading off the tax advantages of debt against the risk of costly default. The costs of bankruptcy are endogenously determined, as bankrupt firms are forced to liquidate their assets, resulting in a fire sale if the market is illiquid. When the corporate income tax rate is positive, firms have a unique optimal capital structure. In equilibrium firms default with positive probability and their assets are liquidated at fire-sale prices. The equilibrium not only features underinvestment but is also constrained inefficient. In particular there is too little debt and too little default.

Item Type: Monograph (Discussion Paper)
Official URL: http://www.systemicrisk.ac.uk/
Additional Information: © 2014 Systemic Risk Centre, The London School of Economics and Political Science
Divisions: Systemic Risk Centre
Subjects: H Social Sciences > HG Finance
JEL classification: D - Microeconomics > D5 - General Equilibrium and Disequilibrium
D - Microeconomics > D6 - Welfare Economics
G - Financial Economics > G3 - Corporate Finance and Governance > G32 - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure
G - Financial Economics > G3 - Corporate Finance and Governance > G33 - Bankruptcy; Liquidation
Sets: Research centres and groups > Systemic Risk Centre
Date Deposited: 16 Feb 2015 15:19
Last Modified: 14 Mar 2019 00:04
Projects: ES/K002309/1
Funders: Economic and Social Research Council
URI: http://eprints.lse.ac.uk/id/eprint/60958

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