Debt Dynamics

62 Pages Posted: 21 Jul 2003

See all articles by Chris Hennessy

Chris Hennessy

London Business School

Toni M. Whited

University of Michigan, Stephen M. Ross School of Business; National Bureau of Economic Research

Date Written: June 16, 2003


We develop a dynamic model of financial and investment policy with corporate and individual taxes, costly equity issuance, and debt constraints. The dynamic framework allows us to explain a number of empirical findings inconsistent with static tax-based theories. We show that: 1) there is no target leverage ratio; 2) firms can be savers or heavily levered; 3) leverage is path dependent and exhibits hysteresis; 4) leverage is decreasing in lagged liquidity; and 5) leverage varies negatively with an external finance weighted-average Q ratio. In the empirical section, we estimate key structural parameters using a simulation estimator.

Keywords: Capital structure, taxes, dynamic model, indirect inference

JEL Classification: G32,G31

Suggested Citation

Hennessy, Christopher and Whited, Toni M., Debt Dynamics (June 16, 2003). Available at SSRN: or

Christopher Hennessy

London Business School ( email )

Sussex Place
Regent's Park
London, London NW1 4SA
United Kingdom

Toni M. Whited (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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