The Gains from Resolving Debt Overhang: Evidence from a Structural Estimation

David Zeke and Robert Kurtzman

No 1301, 2016 Meeting Papers from Society for Economic Dynamics

Abstract: What are the gains from resolving debt overhang for firm growth and aggregate welfare? To address this question, we develop a general equilibrium model where heterogeneous firms innovate to grow, can potentially default on their debt obligations, and can suffer from debt overhang. We estimate the model with data on U.S. nonfinancial public firms using indirect inference and obtain bounds on the extent to which debt overhang affects firm growth that are consistent with existing estimates in the corporate finance literature. We find that while the private gains to a firm from resolving debt overhang can be large if it faces sufficient default risk, the expected gains to firms on average are relatively modest. The social gains to long-run consumption and output from resolving debt overhang are smaller, as an endogenous rise in the real cost of innovation and the aggregate bankruptcy rate act as dampening forces. However, our model suggests the gains from resolving debt overhang over the business cycle can be large, as firm default risk rises significantly during the recession, which implies a significant decrease in innovation and subsequent firm growth.

Date: 2016
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Persistent link: https://EconPapers.repec.org/RePEc:red:sed016:1301

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