Abstract

https://ssrn.com/abstract=2304969
 
 

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The Leverage Ratchet Effect


Anat R. Admati


Stanford Graduate School of Business

Peter M. DeMarzo


Stanford Graduate School of Business; National Bureau of Economic Research (NBER)

Martin F. Hellwig


Max Planck Institute for Research on Collective Goods; University of Bonn - Department of Economics

Paul C. Pfleiderer


Stanford Graduate School of Business

October 11, 2016

Preprints of the Max Planck Institute for Research on Collective Goods Bonn 2013/13
Rock Center for Corporate Governance at Stanford University Working Paper No. 146

Abstract:     
Firms’ inability to commit to future funding choices has profound consequences for capital structure dynamics. With debt in place, shareholders pervasively resist leverage reductions no matter how much such reductions may enhance firm value. Shareholders would instead choose to increase leverage even if debt levels are already high and new debt must be junior to existing debt. These asymmetric forces in leverage adjustments, which we call the leverage ratchet effect, cause equilibrium leverage outcomes to be history-dependent. When forced to reduce leverage, shareholders are biased toward selling assets relative to potentially more efficient alternatives such as pure recapitalizations. This version: October 11, 2016

Number of Pages in PDF File: 54

Keywords: capital structure, leverage, agency costs of debt, dynamic capital structure, tradeoff theory of capital structure, capital regulation, bank equity, debt overhang, under-investment, recapitalization, deleveraging, bankruptcy costs

JEL Classification: G21, G28, G32, G33, G35, G38, H81, K23


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Date posted: August 2, 2013 ; Last revised: October 12, 2016

Suggested Citation

Admati, Anat R. and DeMarzo, Peter M. and Hellwig, Martin F. and Pfleiderer, Paul C., The Leverage Ratchet Effect (October 11, 2016). Preprints of the Max Planck Institute for Research on Collective Goods Bonn 2013/13; Rock Center for Corporate Governance at Stanford University Working Paper No. 146. Available at SSRN: https://ssrn.com/abstract=2304969 or http://dx.doi.org/10.2139/ssrn.2304969

Contact Information

Anat R. Admati (Contact Author)
Stanford Graduate School of Business ( email )
655 Knight Way
Stanford, CA 94305-5015
United States
650-723-4987 (Phone)
650-725-6152 (Fax)

Peter M. DeMarzo
Stanford Graduate School of Business ( email )
655 Knight Way
Stanford, CA 94305-5015
United States
650-736-1082 (Phone)
650-725-7979 (Fax)
HOME PAGE: http://www.stanford.edu/people/pdemarzo

National Bureau of Economic Research (NBER)
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Martin F. Hellwig
Max Planck Institute for Research on Collective Goods ( email )
Kurt-Schumacher-Str. 10
D-53113 Bonn, 53113
Germany

University of Bonn - Department of Economics
Adenauerallee 24-42
D-53113 Bonn
Germany
Paul C. Pfleiderer
Stanford Graduate School of Business ( email )
655 Knight Way
Stanford, CA 94305-5015
United States
650-723-4495 (Phone)
650-725-7979 (Fax)

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