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

49 Pages Posted: 17 Mar 2012

See all articles by Zhiguo He

Zhiguo He

University of Chicago - Finance

Gregor Matvos

University of Texas at Austin - Department of Finance

Multiple version iconThere are 2 versions of this paper

Date Written: March 2012

Abstract

We illustrate the welfare benefit of tax subsidies to corporate debt financing. Two firms 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 socially beneficial, is costly for the firm. Therefore the planner can increase welfare by subsidizing debt financing. The duration of industry distress determines the tradeoff between the welfare benefit illustrated in our model and the costs of subsidizing corporate debt from the existing literature. Our theory also sheds light on why the IRS considers "conflict of interest" as one of the key determinants in identifying securities that are qualified for tax-benefits.

Suggested Citation

He, Zhiguo and Matvos, Gregor, Debt and Creative Destruction: Why Could Subsidizing Corporate Debt Be Optimal? (March 2012). NBER Working Paper No. w17920. Available at SSRN: https://ssrn.com/abstract=2025307

Zhiguo He (Contact Author)

University of Chicago - Finance ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

HOME PAGE: http://www.zhiguohe.com

Gregor Matvos

University of Texas at Austin - Department of Finance ( email )

Red McCombs School of Business
Austin, TX 78712
United States

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