Debt and Creative Destruction: Why Could Subsidizing Corporate Debt Be Optimal?

45 Pages Posted: 17 Mar 2012 Last revised: 13 Feb 2014

Zhiguo He

University of Chicago - Booth School of Business, and NBER

Gregor Matvos

University of Chicago - Booth School of Business

Multiple version iconThere are 2 versions of this paper

Date Written: July 1, 2013

Abstract

We illustrate the welfare benefit of tax subsidies to corporate debt financing and study how the social cost/benefit trade-off of the subsidy changes with the duration of industry distress. To illustrate the benefit, we model two firms, which engage in a socially wasteful competition for survival in a declining industry. Firms differ on two dimensions: exogenous productivity and endogenously chosen amount of debt financing, resulting in a two dimensional war of attrition. Debt financing increases incentives to exit, which, while costly for the firm, is socially beneficial. These benefits decline as industry distress shortens, and the planner trades them off with increased costs of subsidizing corporate debt from the existing literature. In practice, debt payments are only subsidized for profitable firms — this implementation arises naturally in our normative model, even though the goal of the policy is to entice low productivity firms to take on debt.

Suggested Citation

He, Zhiguo and Matvos, Gregor, Debt and Creative Destruction: Why Could Subsidizing Corporate Debt Be Optimal? (July 1, 2013). Fama-Miller Working Paper; Chicago Booth Research Paper No. 12-34; AFA 2013 San Diego Meetings Paper. Available at SSRN: https://ssrn.com/abstract=2023645 or http://dx.doi.org/10.2139/ssrn.2023645

Zhiguo He (Contact Author)

University of Chicago - Booth School of Business, and NBER ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

HOME PAGE: http://faculty.chicagobooth.edu/zhiguo.he/pubs.html

Gregor Matvos

University of Chicago - Booth School of Business ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

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