Competitive equilibrium with debt

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Abstract

This paper studies the interaction among financing, entry, and exit decisions of firms in a competitive industry subject to aggregate uncertainty. In contrast to Fries, Miller, and Perraudin (1997), I do not assume that a firm in default leaves the industry immediately. The implications on the optimal leverage ratios and equilibrium credit spreads are discussed. By incorporating the effect of competition, I show that the model results in significantly higher credit spreads than those predicted by traditional single firm models. Dynamic capital structure strategies in a competitive industry are also examined. The model renders a number of empirical predictions regarding leverage ratios and credit spreads of firms in a competitive industry. COPYRIGHT 2007, SCHOOL OF BUSINESS ADMINISTRATION, UNIVERSITY OF WASHINGTON.

Original languageEnglish (US)
Pages (from-to)709-734
Number of pages26
JournalJournal of Financial and Quantitative Analysis
Volume42
Issue number3
DOIs
StatePublished - Sep 2007

All Science Journal Classification (ASJC) codes

  • Accounting
  • Finance
  • Economics and Econometrics

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