Capital Structure and Corporate Financing Decisions: Theory, Evidence, and Practice

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448 Answers to Chapter Discussion Questions

of firms especially regarding entrant firms or those operating in industries in

which customers are interested in long-term support after a sale.

CHAPTER 4 CAPITAL STRUCTURE AND FIRM RISK

1. Empirical findings show that financial leverage amplifies negative economic

shocks. Hence, arguing that excessive financial leverage has made the economic

crisis more severe would be reasonable. Financial leverage increased the vulner-

ability of banks to liquidity shocks, and made firms and consumers more vul-

nerable to the tightening of credit constraints. However, financial leverage alone

is unlikely to have caused the crisis. It cannot easily account for the availability

of cheap money that helped fuel the real estate bubble. Neither can financial

leverage account for the eagerness with which market participants suspended

their belief in basic economic principles. Deregulation, financial innovation, the

failure of corporate governance, and Keynes’ “animal spirits” are just a few of

the other likely culprits.

2. In the presence of capital market imperfections, efficiency no longer guarantees

survival. Efficient firms may be forced to exit the market because they cannot

securefinancing in certain states of the world. Inefficientfirms can survive if they

happen to have more funds when credit constraints become binding. Further,

well-capitalized but inefficient firms actually have incentives ...