Optimal Capital Structure and Industry Dynamics



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    • Jianjun Miao is at the Department of Economics, Boston University. I thank Larry Epstein and Erwan Morellec for constant support and advice. I also thank seminar participants at many institutions, especially, Rui Albuquerque, Mike Barclay, Dan Bernhardt, Pierre Collin-Dufresne, Chris Hennessy, Ludger Hentschel, Burton Hollifield, Hugo Hopenhayn, Boyan Jovanovic, Larry Kotlikoff, Hayne Leland, John Long, Hanno Lustig, Josef Perktold, Victor Rios-Rull, Marc Rysman, Jacob Sagi, Nancy Stokey, Sheridan Titman, and Neng Wang for helpful comments. I am also grateful to an anonymous referee and the editor Robert Stambaugh for extremely helpful comments and suggestions.


This paper provides a competitive equilibrium model of capital structure and industry dynamics. In the model, firms make financing, investment, entry, and exit decisions subject to idiosyncratic technology shocks. The capital structure choice reflects the tradeoff between the tax benefits of debt and the associated bankruptcy and agency costs. The interaction between financing and production decisions influences the stationary distribution of firms and their survival probabilities. The analysis demonstrates that the equilibrium output price has an important feedback effect. This effect has a number of testable implications. For example, high growth industries have relatively lower leverage and turnover rates.