Bankruptcy, finance constraints, and the value of the firm

Douglas Gale; Piero Gottardi

doi:10.1257/mic.3.2.1

Bankruptcy, finance constraints, and the value of the firm

Douglas Gale, Piero Gottardi

Research output: Contribution to journal › Article › peer-review

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.

Original language	English (US)
Pages (from-to)	1-37
Number of pages	37
Journal	American Economic Journal: Microeconomics
Volume	3
Issue number	2
DOIs	https://doi.org/10.1257/mic.3.2.1
State	Published - May 2011

ASJC Scopus subject areas

Economics, Econometrics and Finance(all)

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