Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads
This paper examines the optimal capital structure of a firm which can choose both the amount and maturity of its debt. Bankruptcy is determined endogenously rather than by the imposition of a positive net worth condition or by a cash flow constraint. The results extend Leland's  closed-form results to a much richer class of possible debt structures and permits study of the optimal maturity of debt as well as the optimal amount of debt. The model generates predictions of leverage, credit spreads, default rates, and writedowns which accord quite closely with historical averages. While short term debt does not exploit tax benefits as completely as long term debt, it is more likely to provide incentive compatibility between debtholders and equityholders. The agency costs of "asset substitution" are minimized when the firm uses shorter term debt. The tax advantage of debt must be balanced against bankruptcy and agency costs in determining the optimal maturity of the capital structure. The model predicts differently shaped term structures of credit spreads for different levels of risk. These term structures are similar to that found empirically by Sarig and Warga . The model has important implications for bond portfolio management. In general, Macaulay duration dramatically overstates true duration of risky debt, which may be negative for "junk" bonds. Furthermore, the "convexity" of bond prices can become "concavity."
To our knowledge, this item is not available for
download. To find whether it is available, there are three
1. Check below under "Related research" whether another version of this item is available online.
2. Check on the provider's web page whether it is in fact available.
3. Perform a search for a similarly titled item that would be available.
|Date of creation:||01 Dec 1995|
|Date of revision:|
|Contact details of provider:|| Postal: University of California at Berkeley, Berkeley, CA USA|
Web page: http://haas.berkeley.edu/finance/WP/rpflist.html
More information through EDIRC
|Order Information:|| Postal: IBER, F502 Haas Building, University of California at Berkeley, Berkeley CA 94720-1922|
When requesting a correction, please mention this item's handle: RePEc:ucb:calbrf:rpf-259. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Christopher F. Baum)
If references are entirely missing, you can add them using this form.