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Introducing Capital Structure in a Production Economy: Implications for Investment, Debt and Dividends

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  • Fabio ALESSANDRINI

Abstract

This model adds to the standard neoclassical model of business fluctuations by introducing a more realistic capital structure problem, where firms have to balance the tax benefits of debt with the costs of potential financial distress.Therefore, firms solve a dynamic problem with both an investment and a financing decision. This feature allows firms to finance investment through both retained earnings and debt. As a result, debt will increase after a positive shock and dividends will follow a smoother path. This implies that, as pointed by previous empirical evidence, short-term fluctuations in investment are mostly absorbed by debt and not dividends. The capital structure deteriorates first but then improves after a few quarters. In this model, investment is also inversely related to financial leverage.

Suggested Citation

  • Fabio ALESSANDRINI, 2003. "Introducing Capital Structure in a Production Economy: Implications for Investment, Debt and Dividends," Cahiers de Recherches Economiques du Département d'économie 03.03, Université de Lausanne, Faculté des HEC, Département d’économie.
    • Handle: RePEc:lau:crdeep:03.03
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    Cited by:

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    3. Huang-Meier, Winifred & Freeman, Mark C. & Mazouz, Khelifa, 2015. "Why are aggregate equity payouts pro-cyclical?," Journal of Macroeconomics, Elsevier, vol. 44(C), pages 98-108.
    4. Kirchesch, Kai, 2004. "Financial Risks, Bankruptcy Probabilities, and the Investment Behaviour of Enterprises," Discussion Paper Series 26185, Hamburg Institute of International Economics.

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    More about this item

    Keywords

    capital structure; business cycle; bankruptcy; dividends;
    All these keywords.

    JEL classification:

    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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