Introducing Capital Structure in a Production Economy: Implications for Investment, Debt and Dividends

Fabio Alessandrini

Cahiers de Recherches Economiques du Département d'économie from Université de Lausanne, Faculté des HEC, Département d’économie

Abstract: This model adds to the standard neoclassical model of business fluctuations by introducing a more realistic capital structure problem, where firms have to balance the tax benefits of debt with the costs of potential financial distress.Therefore, firms solve a dynamic problem with both an investment and a financing decision. This feature allows firms to finance investment through both retained earnings and debt. As a result, debt will increase after a positive shock and dividends will follow a smoother path. This implies that, as pointed by previous empirical evidence, short-term fluctuations in investment are mostly absorbed by debt and not dividends. The capital structure deteriorates first but then improves after a few quarters. In this model, investment is also inversely related to financial leverage.

Keywords: capital structure; business cycle; bankruptcy; dividends (search for similar items in EconPapers)
JEL-codes: D92 E22 E32 G32 G33 (search for similar items in EconPapers)
Pages: 36 pages
Date: 2003-02
New Economics Papers: this item is included in nep-cfn, nep-mac and nep-mfd
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

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Persistent link: https://EconPapers.repec.org/RePEc:lau:crdeep:03.03

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