We develop a dynamic model with endogenous choice of leverage, distributions, and real investment in the presence of a graduated corporate income tax, individual taxes on interest and corporate distributions, costs of financial distress, and equity flotation costs. The dynamic trade-off framework allows us to explain a number of empirical findings inconsistent with the static trade-off theory. We show that: 1) there is no target leverage ratio; 2) firms can be savers or heavily levered; 3) leverage is path dependent and exhibits hysteresis; 4) leverage is decreasing in lagged liquidity; and 5) leverage varies negatively with an external finance weighted average Q ratio. In the empirical section, we use simulated moments to estimate key structural parameters
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Paper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number
592.
Length: Date of creation: 2004 Date of revision: Handle: RePEc:red:sed004:592
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Christopher A. Hennessy & Toni M. Whited, 2005.
"Debt Dynamics,"
Journal of Finance,
American Finance Association, vol. 60(3), pages 1129-1165, 06.
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Find related papers by JEL classification: G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure
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