TY  - GEN
AB  - We study how frictions originating from limited liability distort firms' investment and financing choices. By financing new investments with debt, firms can use limited liability to credibly commit to defaulting earlier—allowing both firm owners and new creditors to benefit from diluting existing creditors. In a dynamic setup, this leads to time-inconsistency, increasing the cost of external funds and discouraging investment. We show that the interaction of these two forces leads to heterogeneous investment distortions, where highly-indebted firms overinvest and those with low levels of debt underinvest. Allowing firm owners to pay themselves directly from new debt issuance can mitigate overinvestment but, in the presence of repeated investment opportunities, tends to exacerbate underinvestment among low-leverage firms.
AD  - University of British Columbia
AD  - University of Chicago
AD  - University of British Columbia
AU  - Perla, Jesse
AU  - Pflueger, Carolin
AU  - Szkup, Michal
DA  - 2024-11-08
ID  - 14055
JF  - Journal of Economic Theory
KW  - Limited liability
KW  - Financial friction
KW  - Investment
KW  - Debt financing
L1  - https://knowledge.uchicago.edu/record/14055/files/Commitment-and-investment-distortions-under-limited-liability.pdf
L2  - https://knowledge.uchicago.edu/record/14055/files/Commitment-and-investment-distortions-under-limited-liability.pdf
L4  - https://knowledge.uchicago.edu/record/14055/files/Commitment-and-investment-distortions-under-limited-liability.pdf
LA  - eng
LK  - https://knowledge.uchicago.edu/record/14055/files/Commitment-and-investment-distortions-under-limited-liability.pdf
N2  - We study how frictions originating from limited liability distort firms' investment and financing choices. By financing new investments with debt, firms can use limited liability to credibly commit to defaulting earlier—allowing both firm owners and new creditors to benefit from diluting existing creditors. In a dynamic setup, this leads to time-inconsistency, increasing the cost of external funds and discouraging investment. We show that the interaction of these two forces leads to heterogeneous investment distortions, where highly-indebted firms overinvest and those with low levels of debt underinvest. Allowing firm owners to pay themselves directly from new debt issuance can mitigate overinvestment but, in the presence of repeated investment opportunities, tends to exacerbate underinvestment among low-leverage firms.
PY  - 2024-11-08
T1  - Commitment and investment distortions under limited liability
TI  - Commitment and investment distortions under limited liability
UR  - https://knowledge.uchicago.edu/record/14055/files/Commitment-and-investment-distortions-under-limited-liability.pdf
Y1  - 2024-11-08
ER  -