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Some Aspects of the Pure Theory of Corporate Finance: Bankruptcies and Take-Overs

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  • Joseph E. Stiglitz

Abstract

This paper considers the implications of bankruptcies, take-overs, and divergent expectations for the financial policy of the firm; we argue that, under reasonable assumptions, there is an optimal debt-equity ratio. Previous studies have shown that under very general conditions, if there is no chance of bankruptcy, then financial policy has no effect on the value of the firm; there is no optimal debt-equity ratio. Under certain very restrictive conditions, the no bankruptcy condition may be removed. We show that when these restrictive conditions are not satisfied, and when there is a real possibility of bankruptcy if the firm issues too much debt, the firm's valuation will depend on its debt-equity ratio; the real decisions of the firm (e.g., its investment and choice of technique) cannot be separated from its financial decisions; and the real decisions of the firm may not be productively efficient. Finally, the implications of the possibility of a take-over for the financial policy of the firm are considered.

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Bibliographic Info

Article provided by The RAND Corporation in its journal Bell Journal of Economics.

Volume (Year): 3 (1972)
Issue (Month): 2 (Autumn)
Pages: 458-482

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Handle: RePEc:rje:bellje:v:3:y:1972:i:autumn:p:458-482

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Cited by:
  1. Joseph E. Stiglitz, 2011. "Rethinking Macroeconomics: What Failed, And How To Repair It," Journal of the European Economic Association, European Economic Association, vol. 9(4), pages 591-645, 08.
  2. Lächler, Ulrich, 1985. "Debt versus equity in development finance," Kiel Working Papers 248, Kiel Institute for the World Economy.
  3. Beck, Thorsten & Demirguc-Kunt, Asli & Levine, Ross, 2006. "Bank concentration, competition, and crises: First results," Journal of Banking & Finance, Elsevier, vol. 30(5), pages 1581-1603, May.
  4. Demirguc-Kunt, Asli & Detragiache, Enrica, 2002. "Does deposit insurance increase banking system stability? An empirical investigation," Journal of Monetary Economics, Elsevier, vol. 49(7), pages 1373-1406, October.
  5. Chaney, Paul K. & Thakor, Anjan V., 1985. "Incentive effects of benevolent intervention : The case of government loan guarantees," Journal of Public Economics, Elsevier, vol. 26(2), pages 169-189, March.
  6. Thorsten Beck & Asli Demirguc-Kunt & Ross Levine, 2003. "Bank Concentration and Crises," NBER Working Papers 9921, National Bureau of Economic Research, Inc.
  7. Anton Korinek & Joseph E. Stiglitz, 2008. "Dividend Taxation and Intertemporal Tax Arbitrage," NBER Working Papers 13858, National Bureau of Economic Research, Inc.
  8. Guy V.G. Stevens, 1993. "Internal funds and the investment function," International Finance Discussion Papers 450, Board of Governors of the Federal Reserve System (U.S.).
  9. Ábel, István & Szakadát, László, 1995. "Csőd a piacgazdasági átmenetben
    [The failure of transition to market economy]
    ," Közgazdasági Szemle (Economic Review - monthly of the Hungarian Academy of Sciences), Közgazdasági Szemle Alapítvány (Economic Review Foundation), vol. 0(10), pages 942-954.
  10. Thorsten Beck & Asli Demirguc-Kunt & Ross Levine, 2005. "Bank Concentration and Fragility: Impact and Mechanics," NBER Working Papers 11500, National Bureau of Economic Research, Inc.
  11. Philippe GAUD & Martin HOESLI & André BENDER, 2004. "Further Evidence on Debt-Equity Choice," FAME Research Paper Series rp114, International Center for Financial Asset Management and Engineering.
  12. Bertazzi, Ilaria, 2014. "A challenge to normativity and economic theory, the case ofdebtors movements," Department of Economics and Statistics Cognetti de Martiis. Working Papers 201405, University of Turin.
  13. Demirguc-Kunt, Asli & Detragiache, Enrica, 1997. "The determinants of banking crises : evidence from industrial and developing countries," Policy Research Working Paper Series 1828, The World Bank.

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