Leverage Dynamics without Commitment

Abstract

We characterize equilibrium leverage dynamics in a trade-off model in which the firm can continuously adjust leverage and cannot commit to a policy ex ante. While the leverage ratchet effect leads shareholders to issue debt gradually over time, asset growth and debt maturity cause leverage to mean-revert slowly toward a target. Investors anticipate future debt issuance and raise credit spreads, fully offsetting the tax benefits of new debt. Shareholders are therefore indifferent toward the debt maturity structure, even though their choice significantly affects credit spreads, leverage levels, the speed of adjustment, future investment, and growth.

Debt Refinancing and Equity Returns

“…Moreover, Acharya, Gale, and Yorulmazer (2011) model the role of collateral in rolling over debt, while Brunnermeier and Oehmke (2013) study a strategic game between lenders in determining rollover frequencies. DeMarzo and He (2021). 2 With such benefits of short-term compared to longterm debt, the equity risk implications are opposite those implied by debt rollover risk.…”

“…Such flexibility is crucial to alleviate (agency) costs due to debt overhang. The key idea is that short‐term debt is considered a (commitment) device for equity holders to reduce leverage when cash flows deteriorate, whereas long‐term debt cannot exert such a (disciplining) effect; for recent theoretical work, see Dangl and Zechner (2021) and DeMarzo and He (2021). With such benefits of short‐term compared to long‐term debt, the equity risk implications are opposite those implied by debt rollover risk.…”

“…Following Leland (1998), the firm commits to a stationary debt structure and rolls over a constant amount of debt $$\phi P$$ at each point in time; P denotes the total face (book) value of debt and ϕ the refinancing intensity, where $$0<\phi \le 1$$. Following DeMarzo and He (2021), the instantaneous coupon payment $$cP$$ increases in the face value of debt, where $$c=r/(1-\tau )$$ is a constant. As in Leland (1994), we further assume that there are bankruptcy costs α, and debt holders take over the firm in the event of default and recover only a fraction $$1-\alpha$$ of the unlevered firm value.…”

Стоимость Международных Корпораций: Причины Снижения Долговой Нагрузки В Металлургической И Горнодобывающей Промышленности

“…К идентичным выводам пришли исследователи из Иордании [19]. В свою очередь Peter M. Demarzo и Zhiguo He [10], используя модель компромисса и Марковское идеальное равновесие (Markov perfect equilibrium (MPE)), выявили, что именно держатели акций корректируют уровень долговой нагрузки с целью максимизации текущей цены на акции компании, и заранее выбор целевого коэффициента левериджа не играет важной роли. Так как выпуск долга в дальнейшем приводит к росту активов и сроку погашения, что в свою очередь возвращает рычаг к его изначальному значению.…”

Financial Leverage and Debt Maturity Targeting: International Evidence

“…The importance of capital structure for corporate and real outcomes has been extensively recognized in the extant literature for both small-and medium-sized enterprises (SMEs) and listed firms from developed as well as developing economies (e.g., Anton 2019). An influential view in the theory of capital structure is the existence of an optimal capital structure (Graham and Harvey 2001;DeAngelo et al 2011;Frank and Goyal 2015;DeMarzo and He 2021). Accordingly, a firm's financing choice is not only reflected by its observed debt ratio but also by its target debt ratio and its deviation from the target.…”