Hostname: page-component-7bb8b95d7b-w7rtg Total loading time: 0 Render date: 2024-09-15T23:05:16.979Z Has data issue: false hasContentIssue false
  • English
  • Français

Competitive Equilibrium with Debt

Published online by Cambridge University Press:  06 April 2009

Alexei Zhdanov
Alexei Zhdanov
Affiliation:
[email protected], George Mason University, School of Management, 4400 University Drive, Fairfax, VA 22030.
Get access Rights & Permissions [Opens in a new window]

Abstract

This paper studies the interaction among financing, entry, and exit decisions of firms in a competitive industry subject to aggregate uncertainty. In contrast to Fries, Miller, and Perraudin (1997), I do not assume that a firm in default leaves the industry immediately. The implications on the optimal leverage ratios and equilibrium credit spreads are discussed. By incorporating the effect of competition, I show that the model results in significantly higher credit spreads than those predicted by traditional single firm models. Dynamic capital structure strategies in a competitive industry are also examined. The model renders a number of empirical predictions regarding leverage ratios and credit spreads of firms in a competitive industry.

Type
Research Article
Information
Journal of Financial and Quantitative Analysis , Volume 42 , Issue 3 , September 2007 , pp. 709 - 734
Copyright
Copyright © School of Business Administration, University of Washington 2007

Access options

Get access to the full version of this content by using one of the access options below. (Log in options will check for institutional or personal access. Content may require purchase if you do not have access.)

References

Anderson, R., and Sundaresan, S. M.. “The Design and Valuation of Debt Contracts.” Review of Financial Studies, 9 (1996), 37–68.CrossRefGoogle Scholar
Baldursson, F. “Irreversible Investment under Uncertainty in Oligopoly.” Journal of Economic Dynamics and Control, 22 (1998), 627–644.Google Scholar
Black, F., and Scholes, M.. “The Pricing of Options and Corporate Liabilities.” Journal of Political Economy, 81 (1973), 637–659.Google Scholar
Brander, J. A., and Lewis, T. R.. “Oligopoly and Financial Structure: The Limited Liability Effect.” American Economic Review, 76 (1986), 956–970.Google Scholar
Brander, J. A., and Lewis, T. R.. “Bankruptcy Costs and the Theory of Oligopoly.” Canadian Journal of Economics, 21 (1988), 221–243.Google Scholar
Caballero, R. “Competition and the Non-Robustness of the Investment-Uncertainty Relationship.” American Economic Review, 81 (1991), 279–288.Google Scholar
Caballero, R., and Pindyck, R. S.. “Uncertainty, Investment, and Industry Evolution.” NBER Working Paper No. 4160 (1996).Google Scholar
G., Delianedis, and Geske, R.. “The Components of Corporate Credit Spreads: Default, Recovery, Tax, Jumps, Liquidity, and Market Factors.” Working Paper, University of California at Los Angeles (2002).Google Scholar
A., Dixit “Entry and Exit Decisions under Uncertainty.” Journal of Political Economy, 97 (1989), 620–638.Google Scholar
Dixit, A. “Irreversible Investments and Competition under Uncertainty.” In Capital, Investment and Development, Basu, K., Majumdar, M., and Mitra, T., eds. Cambridge, MA: Basil Blackwell (1993).Google Scholar
Dixit, A., and Pindyck, R.. Investment under Uncertainty. Princeton, NJ: Princeton University Press (1994).Google Scholar
Duffee, G. “The Relation between Treasury Yields and Corporate Bond Yield Spreads.” Journal of Finance, 53 (1998), 2225–2241.Google Scholar
Fan, H., and Sundaresan, S. M.. “Debt Valuation, Renegotiation and Optimal Dividend Policy.” Review of Financial Studies, 13 (2000), 1057–1099.CrossRefGoogle Scholar
Fischer, E.; Heinkel, R.; and Zechner, J.. “Dynamic Capital Structure Choice: Theory and Tests.” Journal of Finance, 44 (1989), 19–40.Google Scholar
Flannery, M., and Rangan, K.. “Partial Adjustment toward Target Capital Structures.” Journal of Financial Economics, 79 (2006), 469–506.Google Scholar
Francois, P., and Morellec, E.. “Debt Valuation, Renegotiation, and Liquidation.” Journal of Business, 77 (2004), 387–411.CrossRefGoogle Scholar
Fries, S.; Miller, M.; and Perraudin, W.. “Debt in Industry Equilibrium.” Review of Financial Studies, 10 (1997), 39–67.Google Scholar
Goldstein, R.; Ju, N.; and Leland, H.. “An EBIT-Based Model of Dynamic Capital Structure.” Journal of Business, 4 (2001), 483–512.Google Scholar
Grenadier, S. “Option Exercise Games: An Application to the Equilibrium Investment Strategies of Firms.” Review of Financial Studies, 15 (2001), 691–721.Google Scholar
Kane, A.; Marcus, A.; and McDonald, R.. “Debt Policy and the Rate of Return Premium to Leverage.” Journal of Financial and Quantitative Analysis, 20 (1985), 479–499.Google Scholar
Lambrecht, B. “The Impact of Debt Financing on Entry and Exit in a Duopoly.” Review of Financial Studies, 14 (2001), 765–804.Google Scholar
J., Leahy “Investment in Competitive Equilibrium: The Optimality of Myopic Behavior.” Quarterly Journal of Economics, 108 (1993), 1105–1133.Google Scholar
Leary, M., and Roberts, M.. “Do Firms Rebalance Their Capital Structures?” Journal of Finance, 60 (2005), 2575–2619.Google Scholar
Leland, H. “Risky Debt, Bond Covenants and Optimal Capital Structure.” Journal of Finance, 49 (1994), 1213–1252.Google Scholar
Lyandres, E. “Capital Structure and Interaction among Firms in Output Markets: Theory and Evidence.” Journal of Business, 79 (2006), 2381–2421.Google Scholar
MacKay, P., and Phillips, G.. “How Does Industry Affect Firm Financial Structure?” Review of Financial Studies, 18 (2005), 1433–1466.Google Scholar
Maksimovic, V. “Capital Structure in Repeated Oligopolies.” Rand Journal of Economics, 19 (1990), 389–407.Google Scholar
Mauer, D. C., and Triantis, A. J.. “Interactions of Corporate Financing and Investment Decisions: A Dynamic Framework.” Journal of Finance, 49 (1994), 1253–1277.Google Scholar
R., Merton “On the Pricing of Corporate Debt: The Risk Structure of Interest Rates.” Journal of Finance, 29 (1974), 449–469.Google Scholar
Miao, J. “Optimal Capital Structure and Industry Dynamics.” Journal of Finance, 6 (2005), 2621–2659.Google Scholar
Modigliani, F., and Miller, M. H.. “The Cost of Capital, Corporation Finance and the Theory of Investment.” American Economic Review, 48 (1958), 261–297.Google Scholar
Phillips, G. “Increased Debt and Industry Product Markets. An Empirical Analysis.” Journal of Financial Economics, 37 (1995), 189–238.Google Scholar
Showalter, D. “Oligopoly and Financial Structure: A Comment.” American Economic Review, 85 (1995), 647–653.Google Scholar
Strebulaev, I. “Do Tests of Capital Structure Theory Mean What They Say?” Journal of Finance, forthcoming (2007).CrossRefGoogle Scholar
Titman, S., and Tsyplakov, S.. “A Dynamic Model of Optimal Capital Structure.” Review of Finance (forthcoming 2007).Google Scholar
Wruck, K. “Financial Distress: Reorganization and Organizational Efficiency.” Journal of Financial Economics, 27 (1990), 419–444.Google Scholar
Zhdanov, A. “Optimal Capital Structure in a Duopoly.” Working Paper, George Mason University (2002).Google Scholar