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

May 13, 2015

We study the impact of agency frictions on the price of defaultable debt in the context of a structural model of corporate decisions. Our model features dynamic investment and long-term debt financing, thus allowing us to analyze many types of possible agency distortions: under- and over-investment, debt claim dilution and excess dividend distributions. We show that shareholders’ incentives to deviate from firm (i.e., equity plus debt) value optimizing policies contribute a significant part of a firm’s credit spread, which we refer to as the agency credit spread. As deviations from firm value maximizing policies are most significant when the firm approaches financial distress, typically in economic downturns, the agency credit spread is large. We find that the mismatch in the maturity of assets and liabilities, the liquidation cost of assets, and the operating leverage of the firm are positively associated with the theoretical agency credit spread. We confirm those predictions in a sample of large S&P500 firms.

Number of Pages in PDF File: 62

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 ; Last revised: May 13, 2015

Suggested Citation

Gamba, Andrea and Aranda, Mamen and Saretto, Alessio, The Agency Credit Spread (May 13, 2015). Available at SSRN: https://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
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