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Debt Dynamics

Chris Hennessy

London Business School

Toni M. Whited

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

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.

Number of Pages in PDF File: 62

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

JEL Classification: G32,G31

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Date posted: July 21, 2003  

Suggested Citation

Hennessy, Chris and Whited, Toni M., Debt Dynamics (June 16, 2003). Available at SSRN: https://ssrn.com/abstract=417200 or http://dx.doi.org/10.2139/ssrn.417200

Contact Information

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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