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Capital Structure, Investment, and Fire Sales

Gale, Douglas and Gottardi, Piero (2015) 'Capital Structure, Investment, and Fire Sales.' Review of Financial Studies, 28 (9). pp. 2502-2533. ISSN 0893-9454

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We study a dynamic general equilibrium model in which firms choose their investment level and capital structure, trading off the tax advantages of debt against the risk of costly default. Bankruptcy costs are endogenous, as bankrupt firms are forced to liquidate their assets, resulting in a fire sale if the market is illiquid. When the corporate income tax rate is positive, firms have a unique optimal capital structure. In equilibrium, firms default with positive probability and their assets are liquidated at fire-sale prices. The equilibrium features underinvestment and is constrained inefficient. In particular there is too little debt and default.

Item Type: Article
Divisions: Faculty of Social Sciences
Faculty of Social Sciences > Economics, Department of
SWORD Depositor: Elements
Depositing User: Elements
Date Deposited: 18 Sep 2019 12:12
Last Modified: 06 Jan 2022 14:57

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