Market frictions and financial decision making

The dissertation examines how capital market frictions including taxes and price opacity affect financial decision making by investors and corporations.; The first essay studies how personal taxes affect corporate investment and financing decisions. I incorporate realization-based capital gains taxation in a tractable dynamic capital budgeting model and derive the cross-sectional and time-series implications for capital structure and investment patterns.; Capital gains taxation causes path-dependency and non-stationarity in the firm's optimal policy, since the tax basis of the firm's owners affects corporate decisions. Ex-ante identical firms follow very different investment policies depending on their stock price evolution. The reason is capital loss offsets reduce investors' uncertainty about after-tax payoffs in down-states. This hedge on personal level speeds up investment on corporate level. However; the inherent asymmetry gradually disappears and the investment threshold shifts up whenever investors reset their tax basis. The investment stimulus is therefore only transitory.; Capital gains taxation also creates incentives to time equity issues, since locked-in incumbent investors value the firm less than the market price of new capital. Firms employ more equity in their capital structure, the lower the basis-to-price ratio of their owners. The value gain from switching to the state-dependent policy is 4--7%.; The second essay, joint with Richard C. Green and Burton Hollifield, studies how decentralization and lack of price transparency affect the competitiveness of securities dealers. The U.S. municipal bond market is a typical decentralized, locally segmented broker-dealer market in which price information is costly to gather. We analyze a comprehensive database comprising every secondary-market transaction in municipal bonds.; We find dealers earn lower average markups the larger the trade size, even though larger trades lead the dealers to bear more risk of losses. The distribution of markups is also highly skewed. A simple structural bargaining model allows us to estimate measures of dealer market power and relate it to characteristics of the trades. The results suggest dealers exercise substantial market power in their trades with customers. The measures of market power decrease in trade size and increase in variables that indicate the trade complexity for the dealer.