A Theory of Corporate Capital Structure and Investment

Miguel Cantillo

No RPF-255, Research Program in Finance Working Papers from University of California at Berkeley

Abstract: This paper develops a costly state verification (CSV) model which describes how financial fluctuations affect real activity in a general equilibrium setting. In an economy with differentiated lenders, the most efficient will become intermediaries (e.g. banks). Intermediation generally creates frictions which prevent banks from dominating the debt markets. In this model, firms with abundant funds avoid intermediaries, and tap the credit markets directly. Meanwhile, firms with moderate resources borrow from intermediaries. The aggregation of this model produces an economy with appealing features: aggregate investment drops with a rise in the riskless rate, and a deterioration of bank or corporate health.

Date: 1995-10-01
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