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Competitive Equilibrium with Debt

Published online by Cambridge University Press:  06 April 2009

Alexei Zhdanov
Affiliation:
zhdanov@gmu.edu, George Mason University, School of Management, 4400 University Drive, Fairfax, VA 22030.

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
Copyright
Copyright © School of Business Administration, University of Washington 2007

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