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A Dynamic Model of Optimal Capital Structure

Author

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  • Sergey Tsyplakov
  • Sheridan Titman

Abstract

This paper presents a continuous time model of a firm that can dynamically adjust both its capital structure and its investment choices. The model extends the existing literature by endogenizing the investment choice as well as firm value, which are both determined by an exogenous price process that describes the firm's product market. Within the context of this model we explore interactions between financial distress costs and debtholder/equityholder agency problems and examine how the ability to dynamically adjust the capital structure choice affects debt choices. The model simultaneously generates quantitative implications on how firm characteristics such as the depreciation rate of the firm's assets, expected future growth opportunities, financial distress costs, taxes and transaction costs affect choice of debt ratios

Suggested Citation

  • Sergey Tsyplakov & Sheridan Titman, 2004. "A Dynamic Model of Optimal Capital Structure," 2004 Meeting Papers 549, Society for Economic Dynamics.
    • Handle: RePEc:red:sed004:549
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    Keywords

    Capital Structure Choice; Investment Decisions; Transaction Costs; Agency Problems;
    All these keywords.

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G34 - Financial Economics - - Corporate Finance and Governance - - - Mergers; Acquisitions; Restructuring; Corporate Governance
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy

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