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Dynamic Capacity Choice, Dynamic Capital Structure, and Credit Risk

69 Pages Posted: 8 Jul 2008 Last revised: 11 Mar 2014

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

Date Written: November 15, 2011

Abstract

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.

Keywords: dynamic capital structure, investment, credit risk, agency costs

JEL Classification: G12, G31, G32, E22

Suggested Citation

Gamba, Andrea and Aranda, Mamen and Saretto, Alessio, Dynamic Capacity Choice, Dynamic Capital Structure, and Credit Risk (November 15, 2011). EFA 2009 Bergen Meetings Paper. Available at SSRN: https://ssrn.com/abstract=1155606 or http://dx.doi.org/10.2139/ssrn.1155606

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
Spain

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

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