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Bankruptcy, Finance Constraints and the Value of the Firm

Douglas Gale () and Piero Gottardi ()

Working Papers from University of Pennsylvania, Wharton School, Weiss Center

Abstract: We study a competitive model in which market incompleteness implies that debt-financed firms may default in some states of nature and default may lead to the sale of the firms' assets at fire sale prices when a finance constraint is binding. The anticipation of such "losses" alone may distort firms' investment decisions. We characterize the conditions under which fire sales occur in equilibrium and their consequences on firms' investment decisions. We also show that endogenous financial crises may arise in this environment, with asset prices collapsing as a result of pure self-fulfilling beliefs. Finally, we examine alternative interventions to restore the efficiency of equilibria.

JEL-codes: D50 D80 G01 G33 (search for similar items in EconPapers)
Date: 2011
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Journal Article: Bankruptcy, Finance Constraints, and the Value of the Firm (2011) Downloads
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