Leverage and Risk-Taking in a Dynamic Model

55 Pages Posted: 2 Jul 2024

See all articles by Tobias Berg

Tobias Berg

Goethe University Frankfurt

Florian Heider

Leibniz Institute for Financial Research SAFE; Goethe University Frankfurt; Centre for Economic Policy Research (CEPR)

Multiple version iconThere are 2 versions of this paper

Date Written: July 02, 2024

Abstract

This paper examines the dynamic relationship between firm leverage and risktaking. We embed the traditional agency problem of asset substitution within a multi-period model, revealing a U-shaped relationship between leverage and risktaking, evident in data from both the U.S. and Europe. Firms with medium leverage avoid risk to preserve the option of issuing safe debt in the future. This option is valuable because safe debt does not incur the expected cost of bankruptcy, anticipated by debt-holders due to future risk-taking incentives. Our model offers new insights on the interaction between companies' debt financing and their risk profiles.

Keywords: leverage, risk-taking incentives, G31, G32, G33, dynamic model

JEL Classification: G3, G31, G32, G33

Suggested Citation

Berg, Tobias and Heider, Florian, Leverage and Risk-Taking in a Dynamic Model (July 02, 2024). SAFE Working Paper No. 423, Available at SSRN: https://ssrn.com/abstract=4883155 or http://dx.doi.org/10.2139/ssrn.4883155

Tobias Berg

Goethe University Frankfurt ( email )

House of Finance
Grueneburgplatz 1
Frankfurt am Main, Hessen 60323
Germany

Florian Heider (Contact Author)

Leibniz Institute for Financial Research SAFE ( email )

House of Finance
Theodor-W.-Adorno-Platz 3
Frankfurt, 60323
Germany

Goethe University Frankfurt ( email )

Finance Department
Theodor-W.-Adorno-Platz 3
Frankfurt am Main, 60323
Germany

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

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