Dynamic Capacity Choice, Dynamic Capital Structure, and Credit Risk
University of Warwick - Finance Group
University of Navarra - Business
University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics
November 15, 2011
EFA 2009 Bergen Meetings Paper
We investigate the joint effect of production capacity choices and capital structure decisions on corporate debt default - related yield spreads. We find that the main driver of credit spreads is the incentive of self-interested shareholders to cash out assets in an economic decline and to under-invest in an upturn. While the importance of these agency issues increases with the ease with which assets can be sold, credit risk shows a non-monotonic relationship with respect to asset liquidity. We also find that changes in corporate tax rates have larger effect on yield spreads than changes in personal tax-rates, even if the net tax shield after both of the changes is the same. The ability to adjust the capital structure considerably reduces credit risk. Finally, bankruptcy costs and debt/equity floatation costs have a relatively insignificant impact on yield spreads.
Number of Pages in PDF File: 69
Keywords: dynamic capital structure, investment, credit risk, agency costs
JEL Classification: G12, G31, G32, E22
Date posted: July 8, 2008 ; Last revised: March 11, 2014
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