Debt Dynamics

Christopher Hennessy and Toni Whited

No 592, 2004 Meeting Papers from Society for Economic Dynamics

Abstract: We develop a dynamic model with endogenous choice of leverage, distributions, and real investment in the presence of a graduated corporate income tax, individual taxes on interest and corporate distributions, costs of financial distress, and equity flotation costs. The dynamic trade-off framework allows us to explain a number of empirical findings inconsistent with the static trade-off theory. We show that: 1) there is no target leverage ratio; 2) firms can be savers or heavily levered; 3) leverage is path dependent and exhibits hysteresis; 4) leverage is decreasing in lagged liquidity; and 5) leverage varies negatively with an external finance weighted average Q ratio. In the empirical section, we use simulated moments to estimate key structural parameters

Keywords: Capital Structure; Dynamic Models (search for similar items in EconPapers)
JEL-codes: G32 (search for similar items in EconPapers)
Date: 2004
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Citations: View citations in EconPapers (12)

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