The Agency Credit Spread

Andrea Gamba

University of Warwick - Finance Group

Mamen Aranda

University of Navarra - Business

Alessio Saretto

University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics

December 31, 2013

Using a neoclassical structural model with dynamic investment and long-term debt financing decisions, we show that debt-equity agency conflicts can contribute a significant part of the credit spread on corporate bonds, which we refer to as the agency credit spread. This spread reflects the incentive of shareholders to deviate from optimal policies that maximize the entire value of the firm (equity plus debt). This is achieved by dynamically exploiting existing unprotected bondholders by diluting their debt claims and under-investing so as to increase the shareholders payout. These effects are inherently countercyclical, in that they are higher in economic downturns and when the firm approaches financial distress. We delineate some testable implications by relating variations in agency credit spreads to variations in some aspects of the model that are conducive of agency conflicts and that can be linked to observable firm characteristics. We confirm those testable implications in a sample of large S&P 500 firms. Under the assumption that the strength of agency frictions is a relevant contributor to credit spreads, we find a positive correlations between changes in credit CDS spreads and changes in asset specificity, operating leverage, and the maturity mis-match between liabilities and assets of the firm.

Number of Pages in PDF File: 55

Keywords: corporate credit risk, credit spread, structural models, debt-equity agency conflicts

JEL Classification: G12, G31, G32, E22

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Date posted: January 1, 2014  

Suggested Citation

Gamba, Andrea and Aranda, Mamen and Saretto, Alessio, The Agency Credit Spread (December 31, 2013). Available at SSRN: http://ssrn.com/abstract=2373423 or http://dx.doi.org/10.2139/ssrn.2373423

Contact Information

Andrea Gamba (Contact Author)
University of Warwick - Finance Group ( email )
Scarman Road
Coventry, CV4 7AL
Great Britain
+44 (0)24 765 24 542 (Phone)
+44 (0)24 765 23 779 (Fax)
Carmen Maria Aranda León
University of Navarra - Business ( email )
Edificio Bibliotecas-Este
Pamplona, 31080
Alessio Saretto
University of Texas at Dallas - School of Management - Department of Finance & Managerial Economics ( email )
800 Campbell Road
SM 31
Richardson, TX 75080
United States
972-883-5907 (Phone)
HOME PAGE: http://www.utdallas.edu/~axs125732
Feedback to SSRN

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