IDEAS home Printed from https://ideas.repec.org/p/ucb/calbrf/rpf-278.html
   My bibliography  Save this paper

Agency Costs, Risk Management, and Capital Structure

Author

Listed:
  • Hayne E. Leland.

Abstract

The joint determination of capital structure and investment risk is examined. Optimal capital structure reflects both the tax advantages of debt less default costs (Modigliani-Miller), and the agency costs resulting from asset substitution (Jensen-Meckling). Agency costs restrict leverage and debt maturity and increase yield spreads, but their importance is relatively small for the range of environments considered. Risk management is also examined. Hedging permits greater leverage. Even when a firm cannot precommit to hedging, it will still do so. Surprisingly, hedging benefits often are greater when agency costs are low.

Suggested Citation

  • Hayne E. Leland., 1998. "Agency Costs, Risk Management, and Capital Structure," Research Program in Finance Working Papers RPF-278, University of California at Berkeley.
  • Handle: RePEc:ucb:calbrf:rpf-278
    as

    Download full text from publisher

    File URL: http://haas.berkeley.edu/finance/WP/rpf278.pdf
    File Function: main text
    Download Restriction: no
    ---><---

    References listed on IDEAS

    as
    1. Gregor Andrade & Steven N. Kaplan, 1997. "How Costly is Financial (not Economic) Distress? Evidence from Highly Leveraged Transactions that Became Distressed," NBER Working Papers 6145, National Bureau of Economic Research, Inc.
    2. Jones, E Philip & Mason, Scott P & Rosenfeld, Eric, 1984. "Contingent Claims Analysis of Corporate Capital Structures: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 39(3), pages 611-625, July.
    3. Mian, Shehzad L., 1996. "Evidence on Corporate Hedging Policy," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 31(3), pages 419-439, September.
    4. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    5. Duffie, Darrell & Lando, David, 2001. "Term Structures of Credit Spreads with Incomplete Accounting Information," Econometrica, Econometric Society, vol. 69(3), pages 633-664, May.
    6. Robert A. Jarrow & David Lando & Stuart M. Turnbull, 2008. "A Markov Model for the Term Structure of Credit Risk Spreads," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 18, pages 411-453, World Scientific Publishing Co. Pte. Ltd..
    7. Kane, Alex & Marcus, Alan J & McDonald, Robert L, 1984. "How Big Is the Tax Advantage to Debt?," Journal of Finance, American Finance Association, vol. 39(3), pages 841-853, July.
    8. Robert A. Jarrow & Stuart M. Turnbull, 2008. "Pricing Derivatives on Financial Securities Subject to Credit Risk," World Scientific Book Chapters, in: Financial Derivatives Pricing Selected Works of Robert Jarrow, chapter 17, pages 377-409, World Scientific Publishing Co. Pte. Ltd..
    9. Merton, Robert C, 1974. "On the Pricing of Corporate Debt: The Risk Structure of Interest Rates," Journal of Finance, American Finance Association, vol. 29(2), pages 449-470, May.
    10. Wiggins, James B., 1990. "The Relation between Risk and Optimal Debt Maturity and the Value of Leverage," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 25(3), pages 377-386, September.
    11. Brennan, Michael J & Schwartz, Eduardo S, 1984. "Optimal Financial Policy and Firm Valuation," Journal of Finance, American Finance Association, vol. 39(3), pages 593-607, July.
    12. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
    13. Harris, Milton & Raviv, Artur, 1991. "The Theory of Capital Structure," Journal of Finance, American Finance Association, vol. 46(1), pages 297-355, March.
    14. Brennan, Michael J & Schwartz, Eduardo S, 1985. "Evaluating Natural Resource Investments," The Journal of Business, University of Chicago Press, vol. 58(2), pages 135-157, April.
    15. Fischer, Edwin O & Heinkel, Robert & Zechner, Josef, 1989. " Dynamic Capital Structure Choice: Theory and Tests," Journal of Finance, American Finance Association, vol. 44(1), pages 19-40, March.
    16. Black, Fischer & Scholes, Myron S, 1973. "The Pricing of Options and Corporate Liabilities," Journal of Political Economy, University of Chicago Press, vol. 81(3), pages 637-654, May-June.
    17. Miller, Merton H, 1977. "Debt and Taxes," Journal of Finance, American Finance Association, vol. 32(2), pages 261-275, May.
    18. Tufano, Peter, 1996. "Who Manages Risk? An Empirical Examination of Risk Management Practices in the Gold Mining Industry," Journal of Finance, American Finance Association, vol. 51(4), pages 1097-1137, September.
    19. Fisher, Lawrence, 1984. "Contingent Claims Analysis of Corporate Capital Structures: An Empirical Investigation," Journal of Finance, American Finance Association, vol. 39(3), pages 625-627, July.
    20. Anderson, Ronald W & Sundaresan, Suresh, 1996. "Design and Valuation of Debt Contracts," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 37-68.
    21. Froot, Kenneth A & Scharfstein, David S & Stein, Jeremy C, 1993. "Risk Management: Coordinating Corporate Investment and Financing Policies," Journal of Finance, American Finance Association, vol. 48(5), pages 1629-1658, December.
    22. Mauer, David C & Triantis, Alexander J, 1994. "Interactions of Corporate Financing and Investment Decisions: A Dynamic Framework," Journal of Finance, American Finance Association, vol. 49(4), pages 1253-1277, September.
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Lim, Terence & Lo, Andrew W. & Merton, Robert C. & Scholes, Myron S., 2006. "The Derivatives Sourcebook," Foundations and Trends(R) in Finance, now publishers, vol. 1(5–6), pages 365-572, April.
    2. Jianjun Miao, 2005. "Optimal Capital Structure and Industry Dynamics," Journal of Finance, American Finance Association, vol. 60(6), pages 2621-2659, December.
    3. Ericsson, Jan & Jacobs, Kris & Oviedo, Rodolfo, 2009. "The Determinants of Credit Default Swap Premia," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 44(1), pages 109-132, February.
    4. Xu, Ruxing & Li, Shenghong, 2010. "Belief updating, debt pricing and financial decisions under asymmetric information," Research in International Business and Finance, Elsevier, vol. 24(2), pages 123-137, June.
    5. Nan Chen & S. G. Kou, 2009. "Credit Spreads, Optimal Capital Structure, And Implied Volatility With Endogenous Default And Jump Risk," Mathematical Finance, Wiley Blackwell, vol. 19(3), pages 343-378, July.
    6. Monda, Barbara & Giorgino, Marco & Modolin, Ileana, 2013. "Rationales for Corporate Risk Management - A Critical Literature Review," MPRA Paper 45420, University Library of Munich, Germany.
    7. Suresh M. Sundaresan, 2000. "Continuous‐Time Methods in Finance: A Review and an Assessment," Journal of Finance, American Finance Association, vol. 55(4), pages 1569-1622, August.
    8. Drobetz, Wolfgang & Pensa, Pascal & Wöhle, Claudia B., 2004. "Kapitalstrukturtheorie in Theorie und Praxis: Ergebnisse einer Fragebogenuntersuchung," Working papers 2004/09, Faculty of Business and Economics - University of Basel.
    9. Augusto Castillo, 2004. "Firm and Corporate Bond Valuation: A Simulation Dynamic Programming Approach," Latin American Journal of Economics-formerly Cuadernos de Economía, Instituto de Economía. Pontificia Universidad Católica de Chile., vol. 41(124), pages 345-360.
    10. Hui Chen & Jianjun Miao & Neng Wang, 2010. "Entrepreneurial Finance and Nondiversifiable Risk," Review of Financial Studies, Society for Financial Studies, vol. 23(12), pages 4348-4388, December.
    11. Viral V. Acharya & Jennifer N. Carpenter, 2002. "Corporate Bond Valuation and Hedging with Stochastic Interest Rates and Endogenous Bankruptcy," Review of Financial Studies, Society for Financial Studies, vol. 15(5), pages 1355-1383.
    12. Reneby, Joel & Ericsson, Jan, 2001. "The Valuation of Corporate Liabilities: Theory and Tests," SSE/EFI Working Paper Series in Economics and Finance 445, Stockholm School of Economics, revised 07 Jan 2003.
    13. Ming Fang & Rui Zhong, 2004. "Default Risk, Firm's Characteristics, and Risk Shifting," Yale School of Management Working Papers amz2461, Yale School of Management, revised 01 Mar 2005.
    14. Moraux, Franck, 2004. "Modeling the business risk of financially weakened firms: A new approach for corporate bond pricing," International Review of Financial Analysis, Elsevier, vol. 13(1), pages 47-61.
    15. Duffie, Darrell, 2005. "Credit risk modeling with affine processes," Journal of Banking & Finance, Elsevier, vol. 29(11), pages 2751-2802, November.
    16. Martin Dòzsa & Karel Janda, 2015. "Corporate asset pricing models and debt contracts," CAMA Working Papers 2015-33, Centre for Applied Macroeconomic Analysis, Crawford School of Public Policy, The Australian National University.
    17. repec:wyi:journl:002109 is not listed on IDEAS
    18. Dragon Tang & Hong Yan, 2006. "Macroeconomic Conditions, Firm Characteristics, and Credit Spreads," Journal of Financial Services Research, Springer;Western Finance Association, vol. 29(3), pages 177-210, June.
    19. Samuel Chege Maina, 2011. "Credit Risk Modelling in Markovian HJM Term Structure Class of Models with Stochastic Volatility," PhD Thesis, Finance Discipline Group, UTS Business School, University of Technology, Sydney, number 1-2011, August.
    20. Söhnke M. Bartram & Gregory W. Brown & Frank R. Fehle, 2009. "International Evidence on Financial Derivatives Usage," Financial Management, Financial Management Association International, vol. 38(1), pages 185-206, March.
    21. Maclachlan, Iain C, 2007. "An empirical study of corporate bond pricing with unobserved capital structure dynamics," MPRA Paper 28416, University Library of Munich, Germany.

    More about this item

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:ucb:calbrf:rpf-278. 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: . General contact details of provider: https://edirc.repec.org/data/debrkus.html .

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Christopher F. Baum (email available below). General contact details of provider: https://edirc.repec.org/data/debrkus.html .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service hosted by the Research Division of the Federal Reserve Bank of St. Louis . RePEc uses bibliographic data supplied by the respective publishers.