Credit Market Frictions and Capital Structure Dynamics
Julien N. Hugonnier
Swiss Federal Institute of Technology Lausanne - Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute
Ecole Polytechnique Federale de Lausanne and Swiss Finance Institute; Swiss Finance Institute
Swiss Finance Institute; Ecole Polytechnique Fédérale de Lausanne
September 10, 2012
We study the implications of credit market frictions for the dynamics of corporate capital structure and the risk of default of corporations. To do so, we develop a dynamic capital structure model in which firms face uncertainty regarding their ability to raise funds in credit markets and have to search for investors when seeking to adjust their capital structure. We provide a general analysis of shareholders' dynamic financing and default decisions, show when rational expectations equilibria in financing and default barrier strategies exist, and when uniqueness can be achieved. We then use the model to generate a number of novel testable implications relating credit market frictions to target leverage, the pace and size of capital structure changes, creditor turnover, and the likelihood of default.
Number of Pages in PDF File: 67
Keywords: Credit supply uncertainty, dynamic capital structure, default risk, searchworking papers series
Date posted: March 16, 2012 ; Last revised: October 17, 2012
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