A Direct Test of Agency Theories of Debt
52 Pages Posted: 20 Jun 2014
Date Written: June 18, 2014
Abstract
When a firm is facing default, equity holders have incentives to engage in asset substitution, underinvest, or directly transfer wealth. Few papers document investment distortions on account of debt-equity agency conflicts, only that the threat of distortions influence ex ante financing costs. A non-agency RMBS deal represents an entity that is highly leveraged where, ex ante, equity holders know they will face default. This provides an ideal laboratory for testing whether the threat of default creates any of the distortions predicted in theory. We estimate agency costs associated with direct wealth transfers to range between $.011 and $.025 per dollar.
Keywords: Agency Costs of Debt, Securitization
JEL Classification: G32, G28, G21
Suggested Citation: Suggested Citation
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