Optimal Capital Structure and Industry Dynamics

Abstract:     
This paper provides a competitive equilibrium model of capital structure and industry dynamics. In the model, firms make financing, investment, entry, and exit decisions subject to idiosyncratic technology shocks. The capital structure choice reflects the tradeoff between the tax benefits of debt and the associated bankruptcy and agency costs. The interaction between financing and production decisions influences the stationary distribution of firms and their survival probabilities. The analysis demonstrates that the equilibrium output price has an important feedback effect. Due to this effect, the model generates a number of new testable predictions. In particular, it is shown that high-growth industries have relatively lower leverage and lower turnover rates.

Number of Pages in PDF File: 46

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