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Corporate leverage and currency crises

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  • Bris, Arturo
  • Koskinen, Yrjo

Abstract

This paper provides an explanation of currency crises based on an argument that bailing out financially distressed exporting firms through a currency depreciation is ex-post optimal. Exporting firms have profitable investment opportunities, but they will not invest because high leverage causes debt overhang problems. The government can make investments feasible by not defending a fixed exchange rate and letting the currency depreciate. Currency depreciation always increases the profitability of new investments when revenues are in a foreign currency and costs are at least partially in domestic. Interestingly, foreign borrowing by exporting firms doesn't change the qualitative results: if firms' debt is denominated in foreign currency, a larger depreciation is needed to restore incentives to invest. An important feature in our model is that in general exporting firms choose to finance investments with debt instead of equity. Currency depreciation is socially optimal if risky projects have a higher expected return than safe projects and if firms

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Financial Economics.

Volume (Year): 63 (2002)
Issue (Month): 2 (February)
Pages: 275-310

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Handle: RePEc:eee:jfinec:v:63:y:2002:i:2:p:275-310

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Web page: http://www.elsevier.com/locate/inca/505576

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