The Optimal Capital Structure of an Economy

U. of Heidelberg Economics Working Paper No. 359

31 Pages Posted: 15 Aug 2001

See all articles by Hans Gersbach

Hans Gersbach

ETH Zurich - CER-ETH -Center of Economic Reseaarch; IZA Institute of Labor Economics; CESifo (Center for Economic Studies and Ifo Institute); Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: August 2001

Abstract

In a general equilibrium model we examine the optimal allocation of equity and debt across banks and industrial firms when both are plagued by incentive problems and firms can borrow from banks. Competition among banks will not result in a socially efficient level of equity. Imposing capital requirements on banks can trigger the socially optimal capital structure of an economy in the sense of maximizing aggregate output. Such capital regulation is second-best and must balance three costs: gambling of banks, credit restrictions banks impose on firms with low equity, and credit restrictions because of high loan interest rates.

Keywords: Financial intermediation, double incentive problems, bank capital, banking regulation, capital structure of the economy

JEL Classification: D41, E4, G2

Suggested Citation

Gersbach, Hans, The Optimal Capital Structure of an Economy (August 2001). U. of Heidelberg Economics Working Paper No. 359. Available at SSRN: https://ssrn.com/abstract=278068 or http://dx.doi.org/10.2139/ssrn.278068

Hans Gersbach (Contact Author)

ETH Zurich - CER-ETH -Center of Economic Reseaarch ( email )

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Zurich, 8092
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IZA Institute of Labor Economics

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Germany

CESifo (Center for Economic Studies and Ifo Institute)

Poschinger Str. 5
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Germany

Centre for Economic Policy Research (CEPR)

London
United Kingdom

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