In an incomplete contracting environment, bankruptcy is considered to be a renegotiation of the firm's financial contracts. An optimal bankruptcy law is derived as optimal restrictions on the environment within which the claimants to a distressed firm bargain. The law is used as a commitment...

We examine the impact of explicitly incorporating a measure of debt capacity in recent tests of competing theories of capital structure. Our main results are that if external funds are required, in the absence of debt capacity concerns, debt appears to be preferred to equity. Concerns over debt...