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Corporate Leverage And Currency Crises

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Author Info
Arturo Bris () (International Center for Finance)
Yrjo Juhani Koskinen () (Department of Finance)

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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 are forced to rely on debt financing because of underdeveloped equity markets. Although currency depreciation is always ex-post optimal, it can be harmful ex-ante. Exporting firms know that the government will let the currency depreciate, if their risky investments have failed. This leads to excessive investment in risky projects even if more valuable safe projects are available.

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Paper provided by Yale School of Management in its series Yale School of Management Working Papers with number ysm139.

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Date of creation: 30 Mar 2000
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Handle: RePEc:ysm:somwrk:ysm139

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Find related papers by JEL classification:
G15 - Financial Economics - - General Financial Markets - - - International Financial Markets
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure
F34 - International Economics - - International Finance - - - International Lending and Debt Problems

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

  1. Chang, R. & Velasco, A., 1998. "Financial Crises in Emerging Markets: A Canonical Model," Working Papers 98-21, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
    Other versions:
  2. Flood, Robert P. & Garber, Peter M., 1984. "Collapsing exchange-rate regimes : Some linear examples," Journal of International Economics, Elsevier, vol. 17(1-2), pages 1-13, August. [Downloadable!] (restricted)
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    Other versions:
  4. Ricardo Caballero & Arvind Krishnamurthy, 1999. "Emerging Market Crises: An Asset Markets Perspective," Working papers 99-23, Massachusetts Institute of Technology (MIT), Department of Economics.
    Other versions:
  5. Pomerleano, Michael, 1998. "The East Asia crisis and corporate finances : the untold micro story," Policy Research Working Paper Series 1990, The World Bank. [Downloadable!]
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  9. Gertler, Mark, 1990. "Financial Capacity And Output Fluctuations In An Economy With Multiperiod Financial Relationships," Working Papers 90-44, C.V. Starr Center for Applied Economics, New York University. [Downloadable!]
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  11. Lamont, Owen, 1995. "Corporate-Debt Overhang and Macroeconomic Expectations," American Economic Review, American Economic Association, vol. 85(5), pages 1106-17, December. [Downloadable!] (restricted)
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  13. Roberto Chang & Andres Velasco, 1998. "Financial Fragility and the Exchange Rate Regime," NBER Working Papers 6469, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  14. Bolton, Patrick & Scharfstein, David S, 1996. "Optimal Debt Structure and the Number of Creditors," Journal of Political Economy, University of Chicago Press, vol. 104(1), pages 1-25, February. [Downloadable!] (restricted)
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  16. Roberto Chang & Andres Velasco, 1998. "Financial Crises in Emerging Markets," NBER Working Papers 6606, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  17. Rafael La Porta & Florencio Lopez-de-Silanes & Andrei Shleifer & Robert W. Vishny, 1998. "Law and Finance," Journal of Political Economy, University of Chicago Press, vol. 106(6), pages 1113-1155, December. [Downloadable!] (restricted)
    Other versions:
  18. Douglas W. Diamond & Philip H. Dybvig, 2000. "Bank runs, deposit insurance, and liquidity," Quarterly Review, Federal Reserve Bank of Minneapolis, issue Win, pages 14-23. [Downloadable!]
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  19. Johnson, Simon & Boone, Peter & Breach, Alasdair & Friedman, Eric, 2000. "Corporate governance in the Asian financial crisis," Journal of Financial Economics, Elsevier, vol. 58(1-2), pages 141-186. [Downloadable!] (restricted)
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  20. Perotti, Enrico C & Spier, Kathryn E, 1993. "Capital Structure as a Bargaining Tool: The Role of Leverage in Contract Renegotiation," American Economic Review, American Economic Association, vol. 83(5), pages 1131-41, December. [Downloadable!] (restricted)
    Other versions:
  21. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November. [Downloadable!] (restricted)
Full references

Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Galina Hale & Carlos Arteta, 2007. "Currency crises and foreign credit in emerging markets: credit crunch or demand effect?," Working Paper Series 2007-02, Federal Reserve Bank of San Francisco. [Downloadable!]
  2. Júnior, José L. R., 2008. "Corporate Financial Policies and the Exchange Rate Regime: Evidence from Brazil," Ibmec Working Papers wpe_142, Ibmec Working Paper, Ibmec São Paulo. [Downloadable!]
  3. Mihir A. Desai & C. Fritz Foley & Kristin J. Forbes, 2004. "Financial Constraints and Growth: Multinational and Local Firm Responses to Currency Crises," NBER Working Papers 10545, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. DeLisle Worrell, 2004. "Quantitative Assessment of the Financial Sector: An Integrated Approach," IMF Working Papers 04/153, International Monetary Fund. [Downloadable!]
  5. Timothy Chue & David Cook, 2004. "Sudden Stops and Liability Dollarization: Evidence from East Asian Financial Intermediaries," Econometric Society 2004 Far Eastern Meetings 646, Econometric Society. [Downloadable!]
  6. Irina Bunda, 2005. "Un modèle de crises jumelles inspiré de la crise asiatique," Post-Print halshs-00424464_v1, HAL. [Downloadable!]
  7. Bris, Arturo & Koskinen, Yrjö & Pons, Vicente, 2001. "Corporate Financial Policies and Performance Around Currency Crises," Working Paper Series in Economics and Finance 467, Stockholm School of Economics, revised 06 Nov 2001. [Downloadable!]
    Other versions:
  8. Jose Luiz Rossi Junior, 2004. "Foreign Exchange exposure, corporate financial policies and the exchange rate regime: Evidence from Brazil," Econometric Society 2004 Latin American Meetings 163, Econometric Society. [Downloadable!]
  9. Arturo Bris & Yrjö Koskinen & Vicente Pons, 2001. "Corporate Financial Policies and Performance Prior to Currency Crises," William Davidson Institute Working Papers Series 386, William Davidson Institute at the University of Michigan Stephen M. Ross Business School. [Downloadable!]
    Other versions:
  10. Irina Bunda, 2006. "A Twin Crisis Model Inspired by the Asian Crisis," Working Papers hal-00422507_v1, HAL. [Downloadable!]
  11. Olli Castrén & Tuomas Takalo, 2000. "Capital market development, corporate governance and the credibility of exchange rate pegs," Working Paper Series 34, European Central Bank. [Downloadable!]
  12. Vaihekoski, Mika, 2008. "History of finance research and education in Finland: the first thirty years," Research Discussion Papers 18/2008, Bank of Finland. [Downloadable!]
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