Capital structure, credit risk, and macroeconomic conditions

Abstract

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 empirical 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 debt contracts with very short maturities. Finally, we characterize the impact of macroeconomic conditions on the pace and size of capital structure changes, and debt capacity. r

Can Banks in Emerging Economies Benefit from Revenue Diversification?

“…A dimension that many studies in this area have ignored but is important in this context. Previous studies suggest that volatility in the macroeconomic and institutional environment that banks operate in undermine their role in efficient risk management (Hardy and Pazarbaşioğlu 1998;Nilsen and Rovelli 2001;Vives 2002;Demirgüç-Kunt and Detragiache 2005;Hackbarth et al 2006). Furthermore, the results in this study suggest that economic growth and development will widen the scope of diversification opportunities for banks as well as boost profitability.…”

Corporate capital structure: the case of large Croatian companies

“…An economic intuition behind the above mentioned arguments is that economy's business cycle phase is an important determinant of capital structure decisions. Moreover, the results of some research have implied that the firm's speed of adjustment toward a target level is faster under favourable macroeconomic conditions (Drobetz, 2006;Hackbarth, Miao, & Morellec, 2006). Korajczyk and Levy (2003) assume the impact of macroeconomic conditions on capital structure taking into consideration a company's financial constraints.…”

“…Their results confirm that the corporate leverage is counter-cyclical for the financially unconstrained firms, which is not consistent with the agency theory of capital structure. Hackbarth et al (2006) propose that balancing the tax benefit of debt and bankruptcy costs in order to reach optimal leverage should depend on macroeconomic conditions. The benefits of debt -interest deductibility and mitigation of agency conflicts between managers and shareholders, depend on the economy's business cycle since economic expansion or recession has important implications for the companies' cash flows.…”

Optimal securitization of credit portfolios via impulse control

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