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Working Paper, No. 2020-20, September 2020 Crossref
Optimal Debt Dynamics, Issuance Costs, and Commitment

We investigate optimal capital structure and debt maturity policies in the presence of fixed issuance costs. We identify the global-optimal policy that generates the highest values of equity across all states of nature consistent with limited liability. The optimal policy without commitment provides almost as much tax benefits to debt as does the global-optimal policy and, in the limit of vanishing issuance costs, allows firms to extract 100% of EBIT. This limiting case does not converge to the equilibrium of DeMarzo and He (2019), who report no tax benefits to debt when issuance costs are set to zero at the outset.


Working papers are not edited, and all opinions and errors are the responsibility of the author(s). The views expressed do not necessarily reflect the views of the Federal Reserve Bank of Chicago or the Federal Reserve System.

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