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

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 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/

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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