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Debt Dynamics

Author

Listed:
  • Christopher Hennessy
  • Toni Whited

Abstract

We develop a dynamic model with endogenous choice of leverage, distributions, and real investment in the presence of a graduated corporate income tax, individual taxes on interest and corporate distributions, costs of financial distress, and equity flotation costs. The dynamic trade-off framework allows us to explain a number of empirical findings inconsistent with the static trade-off theory. We show that: 1) there is no target leverage ratio; 2) firms can be savers or heavily levered; 3) leverage is path dependent and exhibits hysteresis; 4) leverage is decreasing in lagged liquidity; and 5) leverage varies negatively with an external finance weighted average Q ratio. In the empirical section, we use simulated moments to estimate key structural parameters

Suggested Citation

  • Christopher Hennessy & Toni Whited, 2004. "Debt Dynamics," 2004 Meeting Papers 592, Society for Economic Dynamics.
    • Handle: RePEc:red:sed004:592
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    Keywords

    Capital Structure; Dynamic Models;

    JEL classification:

    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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