The Agency Component of Credit Spread

63 Pages Posted: 1 Jan 2014 Last revised: 26 Dec 2019

See all articles by Andrea Gamba

Andrea Gamba

University of Warwick - Finance Group

Alessio Saretto

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

Date Written: February 10, 2018

Abstract

Lack of shareholders' commitment about debt and investment policies increases the cost of debt by a quantity that we refer to as the agency (credit) spread. The agency spread increases with the number of periods for which debt holders are exposed to policies that decrease the value of debt: from 10 basis points or equivalently 5.4% of the average credit spread at one year horizon to 44 basis points and 27%, respectively, at fifty years horizon. At short horizons, small firms with valuable growth options have larger agency spreads. At longer horizons, conversion of options into assets in place and the leverage ratchet effect invert the relationship and deliver higher agency costs for large firms, delivering a non-trivial term structure of the agency credit spread.

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

JEL Classification: G12, G31, G32, E22

Suggested Citation

Gamba, Andrea and Saretto, Alessio, The Agency Component of Credit Spread (February 10, 2018). WBS Finance Group Research Paper No. 213, Available at SSRN: https://ssrn.com/abstract=2373423 or http://dx.doi.org/10.2139/ssrn.2373423

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)

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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