Dividend Policy and Capital Structure of a Defaultable Firm

Alex S. L. Tse

Papers from arXiv.org

Abstract: Default risk significantly affects the corporate policies of a firm. We develop a model in which a limited liability entity subject to Poisson default shock jointly sets its dividend policy and capital structure to maximize the expected lifetime utility from consumption of risk averse equity investors. We give a complete characterization of the solution to the singular stochastic control problem. The optimal policy involves paying dividends to keep the ratio of firm's equity value to investors' wealth below a critical threshold. Dividend payout acts as a precautionary channel to transfer wealth from the firm to investors for mitigation of losses in the event of default. Higher the default risk, more aggressively the firm leverages and pays dividends.

Date: 2018-10
New Economics Papers: this item is included in nep-cfn and nep-upt
References: View references in EconPapers View complete reference list from CitEc
Citations:

Downloads: (external link)
http://arxiv.org/pdf/1810.03501 Latest version (application/pdf)

Related works:
This item may be available elsewhere in EconPapers: Search for items with the same title.

Export reference: BibTeX RIS (EndNote, ProCite, RefMan) HTML/Text

Persistent link: https://EconPapers.repec.org/RePEc:arx:papers:1810.03501

Access Statistics for this paper

More papers in Papers from arXiv.org
Bibliographic data for series maintained by arXiv administrators ().