DEBT IN INDUSTRY EQUILIBRIUM

This article shows (1) bow entry and exit of firms in a competitive in dustry affect the valuation of securities and optimal capital structur e, and (2) how, given a trade-off between tax advantages and agency co sts, a firm will optimally adjust its leverage level after it is set u p. We derive simple pricing expressions for corporate debt in which th e price elasticity of demand for industry output plays a crucial role. When a firm optimally adjusts its leverage over time, we show that to tal firm value comprises the value Of discounted cash flows assuming f ixed capital structure, plus a continuum of options for marginal incre ases in debt.