Debt in industry equilibrium |
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Authors: | Fries S; Miller M; Perraudin W |
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Institution: | 1 European Bank for Reconstruction and Development
2 University of Warwick and CEPR, UK
3 Birkbeck College, London and CEPR, UK |
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Abstract: | This article shows (1) how entry and exit of firms in a competitiveindustry affect the valuation of securities and optimal capitalstructure, and (2) how, given a trade-off between tax advantagesand agency costs, a firm will optimally adjust its leveragelevel after it is set up. We derive simple pricing expressionsfor corporate debt in which the price elasticity of demand forindustry output plays a crucial role. When a firm optimallyadjusts its leverage over time, we show that total firm valuecomprises the value of discounted cash flows assuming fixedcapital structure, plus a continuum of options for marginalincreases in debt. |
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