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American Economic Journal: Microeconomics: Vol. 3 No. 2 (May 2011)

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Bankruptcy, Finance Constraints, and the Value of the Firm

Article Citation

Gale, Douglas, and Piero Gottardi. 2011. "Bankruptcy, Finance Constraints, and the Value of the Firm." American Economic Journal: Microeconomics, 3(2): 1-37.

DOI: 10.1257/mic.3.2.1

Abstract

We study a competitive model in which market incompleteness implies that debt-financed firms may default in some states of nature, and default may lead to the sale of the firms' assets at fire sale prices when a finance constraint is binding. The anticipation of such "losses" alone may distort firms' investment decisions. We characterize the conditions under which fire sales occur in equilibrium, and their consequences on firms' investment decisions. We also show that endogenous financial crises may arise in this environment, with asset prices collapsing as a result of pure self-fulfilling beliefs. Finally, we examine alternative interventions to restore the efficiency of equilibria. (JEL D83, G31, G32, G33)

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Authors

Gale, Douglas (NYU)
Gottardi, Piero (European U Institute, Florence and U Venice)

JEL Classifications

D83: Search; Learning; Information and Knowledge; Communication; Belief
G31: Capital Budgeting; Fixed Investment and Inventory Studies; Capacity
G32: Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure
G33: Bankruptcy; Liquidation

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