Debt Dynamics

Abstract:     
We develop a dynamic model of financial and investment policy with corporate and individual taxes, costly equity issuance, and debt constraints. The dynamic framework allows us to explain a number of empirical findings inconsistent with static tax-based theories. We show that: 1) there is no target leverage ratio; 2) firms can be savers or heavily levered; 3) leverage is path dependent and exhibits hysteresis; 4) leverage is decreasing in lagged liquidity; and 5) leverage varies negatively with an external finance weighted-average Q ratio. In the empirical section, we estimate key structural parameters using a simulation estimator.

Number of Pages in PDF File: 62

Keywords: Capital structure, taxes, dynamic model, indirect inference

JEL Classification: G32,G31

working papers series