Industry Equilibrium Capital Structure

Question 1

Maksimovic 1988

Answer 1

• analyzes the effect of a firm’s capital structure on its product market strategy in the context of a model of repeated oligopoly
• show that there exists an upper bound on the firm’s debt level in the absence of bankruptcy costs
• bound depends on number of firms in industry, the discount rate, the elasticity of demand, and other related factors that affect product market equilibrium in oligopolies.
• show that warrants may decrease equilibrium output in oligopolies
• and that convertible debt and warrants may be used to raise the upper bound on the debt level in specific cases.
• show that the effect of capacity constraints on optimal capital structure is nonmonotonic.

Question 2

Maksimovic and Zechner 1991

Answer 2

• show that risk characteristics of projects’ CFs endog determined by investment decisions of all firms in an industry.
• ⇒ in reasonable settings, fin structures which create incentives to expropriate debtholders by increasing risk are shown not to reduce value in an ind equilib.
• W/o taxes, cap struct irrelevant for indiv firms despite its effect on the equityholders’ incentives,
• but the max total amt of debt in the ind is determinate.
• Allowing for a corp tax advantage of debt, cap structure becomes relevant
• but firms indifferent btw distinct alt debt lvls

Question 3

Shleifer and Vishney 1992

Answer 3

• explore the determinants of liquidation values of assets,
• particularly focusing on the potential buyers of assets.
• When a firm in financial distress needs to sell assets, its industry peers are likely to be experiencing problems themselves ⇒ to asset sales at prices below value in best use.
• Such illiquidity makes assets cheap in bad times, and so ex ante is a significant private cost of leverage.

Question 4

Williams 1995

Answer 4

A subgame perfect Nash equilibrium is characterized for an industry with dissipative costs of agency. In sequence, firms can enter the industry, raise capital with external debt and/or equity, invest in a capital-intensive technology or dissipate capital in perquisites, and finally produce output. For plausible values of two critical parameters, some firms forego in equilibrium investments with positive net present values. Although more managers would like their firms to invest in the capital-intensive technology, they cannot raise the required cash in the capital market. In equilibrium, the industry can have both a profitable core of large, secure, capital-intensive firms, with some debt but no unique optimal capital structure, and a competitive fringe of small, risky, labor-intensive firms. Even as the cost of entry converges to zero, capital-intensive firms can earn extraordinary profits, while all labor-intensive firms fail. With costly agency, access to capital can become a barrier to entry.