Abstract: Optimal Financial Policies under Threat of Bankruptcy

Extract

The dynamic behavior of the corporation has been examined in recent literature by a number of authors. These efforts, however, although attempting to characterize the firm's optimal financing program have neglected to incorporate the threat of bankruptcy associated with these decisions. When the threat of default is appropriately considered, the investment and financing strategies are inexorably joined over time so that determination of an optimal policy becomes a multiperiod problem. The thrust of this paper is to address the problem of determining the firm's dynamic investment-financing program explicitly recognizing the uncertainty of financial ruin attributable to the firm's choice of capital structure.