Risk of Bankruptcy and the Modigliani-Miller theorem in a general equilibrium model of socially responsible investing

We build on the Arrow–Debreu general equilibrium model by Arnold (2023) which features SRI in the form of portfolio preferences. Using assumptions from the classical finance literature, that model is modified such that it allows for bankruptcies. Firm capital inputs are shown to be entirely independent of debt levels, which constitutes the standard corporate finance Modigliani-Miller theorem. As long as debt alterings create no new spanning opportunities and do not destroy old ones, this result extends to a general equilibrium version, implying constant consumption of all individuals. If financial markets are not complete, higher debt may create new spanning opportunities and thus enhance welfare. This result is particularly relevant if individuals constrain the set of firms the assets of which they are willing to hold due to SRI.