Investigating Firm liquidity and Debt Structure, using a Semi-parametric Structural Model

We build a simple dynamic structural model of the firm, with state variable being earnings. It can address general empirical levels of investment, dividends, equity issuance in distress, leverage, debt duration, and liquidation/bankruptcy. Firms with very low leverage carry a substantial cash/liquidity reserve. We extend the model to account for this.Our model can address the ‘puzzles’, under which firms in general, and low leverage firms in particular, would seemingly benefit from taking more leverage. Crucial factors are the difficulty in issuing equity in distress, and limits on debt duration imposed by the willingness of lenders