40 Pages Posted: 23 Apr 2003
Date Written: May 2004
This paper develops a framework for analyzing the impact of macroeconomic conditions on credit risk and dynamic capital structure choice. We begin by observing that when cash flows depend on current economic conditions, there will be a benefit for firms to adapt their default and financing policies to the position of the economy in the business cycle phase. We then demonstrate that this simple observation has a wide range of implications for corporations. Notably, we show that our model can replicate observed debt levels and the countercyclicality of leverage ratios. We also demonstrate that it can reproduce the observed term structure of credit spreads and generate strictly positive credit spreads for very short maturities. Finally, we characterize the impact of macroeconomic conditions on the pace and size of capital structure changes, and debt capacity. A number of new predictions follow.
Keywords: Dynamic Capital Structure, Credit Spreads, Macroeconomic Conditions
JEL Classification: G12, G32, G33
Suggested Citation: Suggested Citation
Miao, Jianjun and Hackbarth, Dirk and Morellec, Erwan, Capital Structure, Credit Risk, and Macroeconomic Conditions (May 2004). Simon School of Business Working Paper No. FR 03-10. Available at SSRN: https://ssrn.com/abstract=395480 or http://dx.doi.org/10.2139/ssrn.395480
By John Graham