Cash-flow shortage as an endogenous bankruptcy reason |
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Institution: | 1. School of Economics and Finance, Massey University, New Zealand;2. School of Public Finance, University of Economics Ho Chi Minh City, 59C Nguyen Dinh Chieu, District 3, Ho Chi Minh City 700000, Viet Nam |
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Abstract: | This paper develops a simple model for a leveraged firm and endogenizes the firm’s bankruptcy point by assuming that equity issuance is costly. Equity-issuance costs reflect the difficulties in issuing new equity for firms that are close to financial distress. The resulting model captures cash-flow shortage as a reason to go bankrupt, though the equity value is positive. I analyze the optimal bankruptcy point as well as corporate bond prices and yield spreads for various levels of equity-issuance costs in order to study the impact of different liquidity constraints. Finally, I discuss the consequences on optimal capital structure. |
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