Industry Dynamics and Capital Structure (Non)Commitment
50 Pages Posted: 19 Jun 2020 Last revised: 16 Nov 2020
Date Written: May 11, 2020
We develop a competitive equilibrium model of leverage and industry dynamics absent of equity holders’ commitment to future debt levels. Shareholders determine the debt adjustment together with production, entry and exit decisions in response to firm-specific technology shocks. Non-commitment gives rise to debt issuance, which increases the cost of debt financing. Consequently, the entry barrier is raised, hindering entries into the market. Meanwhile, the resultant higher output price alleviates debt-equity conflicts for firms already in the industry. More importantly, non-commitment increases the mass of high-leverage firms, reshaping the distribution of the firm universe and escalating industry turnover and leverage. The results are aligned with empirical distribution features, suggesting debt-equity conflicts at the firm level can have a profound influence on industry dynamics.
Keywords: capital structure, non-commitment, industry dynamics, product market competition
JEL Classification: E21, E32, G12, G32
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