Price Rigidities and Credit Risk

79 Pages Posted: 25 May 2021 Last revised: 21 Aug 2021

See all articles by Patrick Augustin

Patrick Augustin

McGill University; McGill University, Desautels Faculty of Management

Linxiao Francis Cong

McGill University - Desautels Faculty of Management

Alexandre Corhay

University of Toronto - Rotman School of Management

Michael Weber

University of Chicago - Finance; National Bureau of Economic Research (NBER)

Date Written: August 20, 2021

Abstract

We develop a capital structure model in which firms feature differential flexibility in adjusting output prices to shocks. Inflexible-price firms have lower profits and higher cash-flow volatility, leading in equilibrium to lower financial leverage, shorter debt duration, higher cost of debt, more stringent debt covenants, and higher precautionary cash holdings. Moreover, a cash-flow volatility shock increases the cost of debt more for inflexible-price firms. We confirm these predictions empirically and exploit the 2008 Lehman Brothers bankruptcy to show that inflexible-price firms with higher pre-shock rollover risk exposure experience a significantly larger increase in credit spreads following the event than other firms.

Keywords: sticky prices, monetary policy, credit risk, nominal rigidities

JEL Classification: E12, E44, E52, G12, G28, G32, G33

Suggested Citation

Augustin, Patrick and Augustin, Patrick and Cong, Linxiao and Corhay, Alexandre and Weber, Michael, Price Rigidities and Credit Risk (August 20, 2021). Chicago Booth Research Paper No. 21-14, Fama-Miller Working Paper, Available at SSRN: https://ssrn.com/abstract=3852082 or http://dx.doi.org/10.2139/ssrn.3852082

Patrick Augustin

McGill University ( email )

1001 Sherbrooke St. W
Montreal, Quebec H3A 1G5
Canada

HOME PAGE: http://https://patrickaugustin.ca/

McGill University, Desautels Faculty of Management ( email )

1001 Sherbrooke Street West
Quebec
Montreal, Quebec H3A 1G5
Canada

HOME PAGE: http://www.patrickaugustin.se

Linxiao Cong

McGill University - Desautels Faculty of Management ( email )

1001 Sherbrooke St. West
Montreal, Quebec H3A1G5 H3A 2M1
Canada

Alexandre Corhay

University of Toronto - Rotman School of Management ( email )

105 St. George Street
Toronto, Ontario M5S 3E6 M5S1S4
Canada
4169780512 (Phone)

Michael Weber (Contact Author)

University of Chicago - Finance ( email )

5807 S. Woodlawn Avenue
Chicago, IL 60637
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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