Capital structure, investment, and fire sales

Douglas Gale, Piero Gottardi

    Research output: Contribution to journalReview articlepeer-review


    We study a dynamic general equilibrium model in which firms choose their investment level and capital structure, trading off the tax advantages of debt against the risk of costly default. Bankruptcy costs are endogenous, as bankrupt firms are forced to liquidate their assets, resulting in a fire sale if the market is illiquid. When the corporate income tax rate is positive, firms have a unique optimal capital structure. In equilibrium, firms default with positive probability and their assets are liquidated at fire-sale prices. The equilibrium features underinvestment and is constrained inefficient. In particular there is too little debt and default.

    Original languageEnglish (US)
    Pages (from-to)2502-2533
    Number of pages32
    JournalReview of Financial Studies
    Issue number9
    StatePublished - Sep 2015

    ASJC Scopus subject areas

    • Accounting
    • Finance
    • Economics and Econometrics


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