Dynamic capital structure with callable debt and debt renegotiations

Abstract

We consider a dynamic trade-off model of a firm's capital structure with debt renegotiation. Debt holders only accept restructuring offers from equity holders backed by threats which are in the equity holders' own interest to execute. Our model shows that in a complete information model in which taxes and bankruptcy costs are the only frictions, violations of the absolute priority rule (APR) are typically optimal. The size of the bankruptcy costs and the equity holders' bargaining power affect the size of APR violations, but they have only a minor impact on the choice of capital structure.JEL classification: G32, G33, G13

Debt Maturity and the Dynamics of Leverage

“…They provide results on how maturity affects incentives for subsequent debt issues. Other models consider debt renegotiations and derive partial debt forgiveness outside of bankruptcy (see, e.g., Anderson and Sundaresan (1996); Mella-Barral and Perraudin (1997); Mella-Barral (1999); Christensen, Flor, Lando, and Miltersen (2014)). Mao and Tserlukevich (2015) present a model in which noncoordinated debt holders may accept repurchase offers below the market price when firms pay with existing safe assets or cash.…”

Callable or Convertible Debt? The Role of Debt Overhang and Covenants

“…This table presents our parameters for the base case simulation of the model. Our parameters follow previous literature (e.g., Cooper, 2006;Christensen et al, 2014;Hackbarth and Johnson, 2015).…”

“…The firm receives earnings before interest and taxes (EBIT) at time 𝑡 denoted as 𝑥 𝑡 . EBIT evolves according to a geometric Brownian motion (e.g., Goldstein et al, 2001;Hennessy and Tserlukevich, 2008;Christensen et al, 2014)…”

Corporate Debt, Hybrid Securities, and the Effective Tax Rate

“…This implies that the ratio between the coupon C and the mark-to-market value of debt is equal to the effective interest rate (i.e., the risk-free interest rate plus the default premium). 4 For a detailed analysis of dynamic strategies, with costly debt renegotiation, see, e.g., Broadie, Chernov, and Sundaresan (2007), Christensen et al (2002), Fan and Sundaresan (2000), Fischer, Heinkel, and Zechner (1989), Galai, Raviv, and Wiener (2007), Goldstein, Ju, and Leland (2001), Hennessy and Whited (2005) and Mella-Barral (1999). 5 The quality of results does not change if, according to Leland (1994), we assume that the default sunk cost is proportional to a firm's value.…”

“…4 4 For a detailed analysis of dynamic strategies, with costly debt renegotiation, see, e.g., Broadie, Chernov, and Sundaresan (2007), Christensen et al . (2002), Fan and Sundaresan (2000), Fischer, Heinkel, and Zechner (1989), Galai, Raviv, and Wiener (2007), Goldstein, Ju, and Leland (2001), Hennessy and Whited (2005) and Mella‐Barral (1999). …”