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Bankruptcy, Finance Constraints and the Value of the Firm

Author

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  • Gale, Douglas

    (NYU)

  • Gottardi, Piero

    (European University Institute, Florence and University of Venice)

Abstract

We study a competitive model in which market incompleteness implies that debt-financed firms may default in some states of nature and default may lead to the sale of the firms' assets at fire sale prices when a finance constraint is binding. The anticipation of such "losses" alone may distort firms' investment decisions. We characterize the conditions under which fire sales occur in equilibrium and their consequences on firms' investment decisions. We also show that endogenous financial crises may arise in this environment, with asset prices collapsing as a result of pure self-fulfilling beliefs. Finally, we examine alternative interventions to restore the efficiency of equilibria.

Suggested Citation

  • Gale, Douglas & Gottardi, Piero, 2011. "Bankruptcy, Finance Constraints and the Value of the Firm," Working Papers 11-09, University of Pennsylvania, Wharton School, Weiss Center.
    • Handle: RePEc:ecl:upafin:11-09
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    File URL: http://fic.wharton.upenn.edu/fic/papers/11/11-09.pdf
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    Cited by:

    1. Douglas Gale & Piero Gottardi, 2013. "Capital Structure and Investment Dynamics with Fire Sales," Economics Working Papers ECO2013/09, European University Institute.
    2. Douglas Gale & Tanju Yorulmazer, 2020. "Bank capital, fire sales, and the social value of deposits," Economic Theory, Springer;Society for the Advancement of Economic Theory (SAET), vol. 69(4), pages 919-963, June.
    3. Ruwani Fernando, Jayasuriya Mahapatabendige & Li, Leon & Hou, Greg, 2021. "Heterogeneity in capital structure adjustment revisited: Default versus non-default firms and short versus long time horizon," International Review of Economics & Finance, Elsevier, vol. 76(C), pages 185-204.

    More about this item

    JEL classification:

    • D50 - Microeconomics - - General Equilibrium and Disequilibrium - - - General
    • D80 - Microeconomics - - Information, Knowledge, and Uncertainty - - - General
    • G01 - Financial Economics - - General - - - Financial Crises
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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