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Debt Dilution and Debt Overhang

Author

Listed:
  • Joachim Jungherr
  • Immo Schott

Abstract

We introduce risky long-term debt (and a maturity choice) to a dynamic model of firm financing and production. This allows us to study two distortions which are absent from standard models of short-term debt: (1.) Debt dilution distorts firms’ choice of debt which has an indirect effect on investment; (2.) Debt overhang directly distorts investment. In a dynamic model of production, leverage, and debt maturity, we show that the two distortions interact to reduce investment, increase leverage, and increase the default rate. We provide empirical evidence from U.S. firms that is consistent with the model predictions. Debt dilution and debt overhang can overturn standard results: A financial reform which increases investment, employment, output, and welfare in a standard model of short-term debt can have the opposite effect in a model with short-term debt and long-term debt.

Suggested Citation

  • Joachim Jungherr & Immo Schott, 2017. "Debt Dilution and Debt Overhang," Working Papers 997, Barcelona School of Economics.
    • Handle: RePEc:bge:wpaper:997
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    File URL: https://www.barcelonagse.eu/sites/default/files/working_paper_pdfs/997_0.pdf
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    Cited by:

    1. Joachim Jungherr & Immo Schott, 2018. "The Long-term Debt Accelerator," 2018 Meeting Papers 961, Society for Economic Dynamics.
    2. Reiter, Michael & Zessner-Spitzenberg, Leopold, 2023. "Long-term bank lending and the transfer of aggregate risk," Journal of Economic Dynamics and Control, Elsevier, vol. 151(C).

    More about this item

    Keywords

    investment; debt dilution; Debt Overhang;
    All these keywords.

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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