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Safety First, Bankruptcy, and the Pricing and Investment Decisions of the Firm

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  • Ravid, S Abraham

Abstract

This paper analyzes the impact of imposing a constraint on the probability of bankruptcy for the pricing and investment choices of firms. Two models are presented in which a firm faces stochastic demand; in one costs are known with certainty, and in the other costs of production are probabilistic. In both cases the constraint induces a reduction in optimal price if demand is elastic. For less elastic demand, price reductions may be indicated. With constant costs, the constraint lowers optimal investment. The results are applicable to the analysis of rating agencies' behavior or to the design of bond covenants, especially for public utilities. Copyright 1987 by Oxford University Press.

Suggested Citation

  • Ravid, S Abraham, 1987. "Safety First, Bankruptcy, and the Pricing and Investment Decisions of the Firm," Economic Inquiry, Western Economic Association International, vol. 25(4), pages 695-706, October.
    • Handle: RePEc:oup:ecinqu:v:25:y:1987:i:4:p:695-706
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    Cited by:

    1. Zilberman, David & Buschena, David E., 1990. "What We Know About Decision Making Under Uncertainty And Why We Do Not Use What We Know," 1990 Quantifying Long Run Agricultural Risks and Evaluating Farmer Responses to Risk Meeting, January 28-31, 1990, Sanibel Island, Florida 271535, Regional Research Projects > S-232: Quantifying Long Run Agricultural Risks and Evaluating Farmer Responses to Risk.
    2. Grillet, Luc L., 1991. "Insurance hedging in the theory of the firm," Discussion Papers, Series II 166, University of Konstanz, Collaborative Research Centre (SFB) 178 "Internationalization of the Economy".

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