Real and Financial Decisions of a Firm with Bankruptcy and Default: An Integration

Fumio Hayashi

No 1097, NBER Working Papers from National Bureau of Economic Research, Inc

Abstract: This paper attempts to provide a framework for analyzing the interaction between real decisions (concerning investment and factor inputs)and financial decisions (concerning debt and new share issues) of a corporation. The model carries a rich menu of tax rates and explicitly incorporates bankruptcy and default. The firm's multi-period optimization problem is set up where real and financial decisions are simultaneously determined to maximize the value of the firm which is the market price of uncertain future dividends. The main results of the paper are as follows:if the firm's after-tax profits are small relative to investment, the firm finances new investment by retentions and debt; if they are large relative to investment, financing additional investment is done through new shares and debt; in the intermediate case, additional investment is financed entirely by debt.

Date: 1983-03
Note: EFG
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Published as Hayashi, Fumio. "Corporate Finance Side of the Q Theory of Investment," Journal of Public Economics, Vol. 27, No. 3, August 1985, pp. 261-280.

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