Real and Financial Decisions of a Firm with Bankruptcy and Default: An Integration
This paper attempts to provide a framework for analyzing the interaction between real decisions (concerning investment and factor inputs)and financial decisions (concerning debt and new share issues) of a corporation. The model carries a rich menu of tax rates and explicitly incorporates bankruptcy and default. The firm's multi-period optimization problem is set up where real and financial decisions are simultaneously determined to maximize the value of the firm which is the market price of uncertain future dividends. The main results of the paper are as follows:if the firm's after-tax profits are small relative to investment, the firm finances new investment by retentions and debt; if they are large relative to investment, financing additional investment is done through new shares and debt; in the intermediate case, additional investment is financed entirely by debt.
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adjustment costs arbitrage assume bankruptcy and default Bt/Kt+1 capital gains condition with respect corporate bond rate cost of capital cum-dividend defined depreciation allowances derived dividend tax dividends equal equity ex-dividend exogenous variables factor prices financial decisions financial policy firm's optimization problem follows Fumio Hayashi function of F functional form graph hand side homogeneous increase initial condition inverse function Kfc+ Kt+1 l-kt)vt level of investment marginal q marginal tax rate marginal value product Mt+j mtXt NBER nominal interest rate occurs in period optimal decision rule order condition output and factor paper period t+1 pre-existing shares pricing formula pricing operator probability of bankruptcy product of capital profit function PtQt Rational Expectations Real and Financial respect to F returns to scale share issues share price shareholders stochastic stochastic process tax-free technology shock Theorem Torsten Persson value function variable factor inputs Vt(It Wt^Bt,Kt+l