Capital structure, investment, and fire sales

Douglas Gale, Piero Gottardi

    Research output: Contribution to journalReview article

    Abstract

    We study a dynamic general equilibrium model in which firms choose their investment level and capital structure, trading off the tax advantages of debt against the risk of costly default. Bankruptcy costs are endogenous, 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 features underinvestment and is constrained inefficient. In particular there is too little debt and default.

    Original languageEnglish (US)
    Pages (from-to)2502-2533
    Number of pages32
    JournalReview of Financial Studies
    Volume28
    Issue number9
    DOIs
    StatePublished - 2015

    Fingerprint

    Capital structure
    Debt
    Assets
    Corporate income tax
    Underinvestment
    Dynamic general equilibrium model
    Tax rate
    Bankruptcy costs
    Optimal capital structure
    Tax

    ASJC Scopus subject areas

    • Finance
    • Accounting
    • Economics and Econometrics

    Cite this

    Capital structure, investment, and fire sales. / Gale, Douglas; Gottardi, Piero.

    In: Review of Financial Studies, Vol. 28, No. 9, 2015, p. 2502-2533.

    Research output: Contribution to journalReview article

    Gale, Douglas ; Gottardi, Piero. / Capital structure, investment, and fire sales. In: Review of Financial Studies. 2015 ; Vol. 28, No. 9. pp. 2502-2533.
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