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Introducing Capital Structure in a Production Economy: Implications for Investment, Debt and Dividends

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Author Info
Fabio ALESSANDRINI
Abstract

This model adds to the standard neoclassical model of business fluctuations by introducing a more realistic capital structure problem, where firms have to balance the tax benefits of debt with the costs of potential financial distress.Therefore, firms solve a dynamic problem with both an investment and a financing decision. This feature allows firms to finance investment through both retained earnings and debt. As a result, debt will increase after a positive shock and dividends will follow a smoother path. This implies that, as pointed by previous empirical evidence, short-term fluctuations in investment are mostly absorbed by debt and not dividends. The capital structure deteriorates first but then improves after a few quarters. In this model, investment is also inversely related to financial leverage.

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Publisher Info
Paper provided by Université de Lausanne, Faculté des HEC, DEEP in its series Cahiers de Recherches Economiques du Département d'Econométrie et d'Economie politique (DEEP) with number 03.03.

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Length: 36 pages
Date of creation: Feb 2003
Date of revision:
Handle: RePEc:lau:crdeep:03.03

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Postal: Université de Lausanne, Faculté des HEC, DEEP, Internef, CH-1015 Lausanne
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Web page: http://www.hec.unil.ch/deep/publications-english/e-cahiers.htm

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Related research
Keywords: capital structure; business cycle; bankruptcy; dividends;

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Find related papers by JEL classification:
D92 - Microeconomics - - Intertemporal Choice and Growth - - - Intertemporal Firm Choice and Growth, Investment, or Financing
E22 - Macroeconomics and Monetary Economics - - Macroeconomics: Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity
E32 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - Business Fluctuations; Cycles
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure
G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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