53 Pages Posted: 1 Jan 2014 Last revised: 3 Sep 2017
Date Written: August 29, 2017
Lack of shareholders’ commitment about debt and investment policies leads to an increase in the firm’s credit spread, which we refer to as the agency credit spread. We study this effect in a dynamic model of investment and financing, which features long- term debt and allows for several possible distortions of the optimal policy, including debt claim dilution, underinvestment, and asset stripping. We structurally estimate the model and find the average agency credit spread to be about 53 basis points, or equivalently 30% of the overall credit spread. We also find that the shareholders’ incentive to deviate from debt policies aimed at maximizing the value of the firm, the “leverage ratchet effect,” is relatively more important than underinvestment in transferring wealth from debt to equity.
Keywords: corporate credit risk, credit spread, structural models, debt-equity agency conflicts
JEL Classification: G12, G31, G32, E22
Suggested Citation: Suggested Citation