Capital Structure with Endogenous Liquidation Values

36 Pages Posted: 19 Oct 2014 Last revised: 3 Oct 2015

See all articles by Antonio E. Bernardo

Antonio E. Bernardo

University of California, Los Angeles (UCLA) - Finance Area

Alex Fabisiak

University of California, Los Angeles (UCLA) - Anderson School of Management

Ivo Welch

University of California, Los Angeles (UCLA); National Bureau of Economic Research (NBER)

Date Written: October 2, 2015

Abstract

Capital structure theories typically assume liquidation values are exogenous even though they may be determined in part by the debt choices of firms in the industry (Shleifer and Vishny, 1992; Pulvino, 1998). We develop a model in which high industry debt leads to a greater supply of assets for sale by distressed firms but also lower demand for assets from relatively healthy firms because of debt overhang. Thus, high industry debt lowers expected asset liquidation values and provides an incentive for individual firms to take on less debt to take advantage of attractive future buying opportunities. The indirect effect of equilibrium asset prices tempers, and sometimes reverses, the effect of parameters on optimal capital structure choices compared to models with exogenous prices.

Keywords: Capital Structure, Liquidation Values, Financial Distress

JEL Classification: G3

Suggested Citation

Bernardo, Antonio E. and Fabisiak, Alex and Welch, Ivo, Capital Structure with Endogenous Liquidation Values (October 2, 2015). Available at SSRN: https://ssrn.com/abstract=2511379 or http://dx.doi.org/10.2139/ssrn.2511379

Antonio E. Bernardo

University of California, Los Angeles (UCLA) - Finance Area ( email )

Los Angeles, CA 90095-1481
United States
310-825-2198 (Phone)
310-206-5455 (Fax)

Alex Fabisiak

University of California, Los Angeles (UCLA) - Anderson School of Management ( email )

110 Westwood Plaza
Los Angeles, CA 90095-1481
United States

Ivo Welch (Contact Author)

University of California, Los Angeles (UCLA) ( email )

110 Westwood Plaza
C519
Los Angeles, CA 90095-1481
United States
310-825-2508 (Phone)

HOME PAGE: http://www.ivo-welch.info

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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