Bankruptcy, finance constraints, and the value of the firm

Douglas Gale, Piero Gottardi

    Research output: Contribution to journalArticle

    Abstract

    We study a competitive model in which market incompleteness implies that debt-financed firms may default in some states of nature, and default may lead to the sale of the firms' assets at fire sale prices when a finance constraint is binding. The anticipation of such "losses" alone may distort firms' investment decisions. We characterize the conditions under which fire sales occur in equilibrium, and their consequences on firms' investment decisions. We also show that endogenous financial crises may arise in this environment, with asset prices collapsing as a result of pure self-fulfilling beliefs. Finally, we examine alternative interventions to restore the efficiency of equilibria.

    Original languageEnglish (US)
    Pages (from-to)1-37
    Number of pages37
    JournalAmerican Economic Journal: Microeconomics
    Volume3
    Issue number2
    DOIs
    StatePublished - May 2011

    Fingerprint

    Finance
    Bankruptcy
    Firm investment
    Investment decision
    Anticipation
    Competitive model
    Financial crisis
    Nature
    Debt
    Market incompleteness
    Assets
    Asset prices

    ASJC Scopus subject areas

    • Economics, Econometrics and Finance(all)

    Cite this

    Bankruptcy, finance constraints, and the value of the firm. / Gale, Douglas; Gottardi, Piero.

    In: American Economic Journal: Microeconomics, Vol. 3, No. 2, 05.2011, p. 1-37.

    Research output: Contribution to journalArticle

    Gale, Douglas ; Gottardi, Piero. / Bankruptcy, finance constraints, and the value of the firm. In: American Economic Journal: Microeconomics. 2011 ; Vol. 3, No. 2. pp. 1-37.
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