Industry Dynamics and Capital Structure (Non)Commitment

We develop a competitive equilibrium model of leverage and industry dynamics absent of equity holders’ commitment to future debt levels. Shareholders determine the debt adjustment together with production, entry and exit decisions in response to firm-specific technology shocks. Non-commitment gives rise to debt issuance, which increases the cost of debt financing. Consequently, the entry barrier is raised, hindering entries into the market. Meanwhile, the resultant higher output price alleviates debt-equity conflicts for firms already in the industry. More importantly, non-commitment increases the mass of high-leverage firms, reshaping the distribution of the firm universe and escalating industry turnover and leverage. The results are aligned with empirical distribution features, suggesting debt-equity conflicts at the firm level can have a profound influence on industry dynamics.