Optimal Time-Consistent Debt Policies

Optimal Debt Dynamics, Issuance Costs, and Commitment

“…There are only a few tractable frameworks in this literature, due to the difficulty of pricing assets in an economy in which their current prices depend on the future debt issuance policy of the firm. 5 Recent papers that investigate whether firms continue to issue debt in high leverage states, or whether they choose to repurchase outstanding debt in this situation, include Dangl and Zechner (2016), Admati et al (2018), Xu (2018, and Malenko and Tsoy (2020). Whereas DH note that their findings are reminiscent of the Coase conjecture for a durable-good monopolist (Coase (1972)), our findings are analogous to the literature that identifies channels through which the Coase conjecture fails.…”

Optimal Debt Dynamics, Issuance Costs, and Commitment

“…There are only a few tractable frameworks in this literature, due to the difficulty of pricing assets in an economy in which their current prices depend on the future debt issuance policy of the firm. 5 Recent papers that investigate whether firms continue to issue debt in high leverage states, or whether they choose to repurchase outstanding debt in this situation, include Dangl and Zechner (2016), Admati et al (2018), Xu (2018), andMalenko andTsoy (2020). Whereas DH note that their findings are reminiscent of the Coase conjecture for a durable-good monopolist (Coase (1972)), our findings are analogous to the literature that identifies channels through which the Coase conjecture fails.…”

“…8 Building on our framework, Malenko and Tsoy (2020) show that firms whose EBIT can jump downward also cannot credibly commit to repurchase their debt, even in the absence of issuance costs.…”

Leverage Dynamics without Commitment

“…Indeed, because our equilibrium produces the lowest possible equilibrium payoff for shareholders (Markov or not), all non-MPE equilibria can be supported by using our equilibrium off the equilibrium path. (See, for example, Benzoni et al (2020) and Malenko and Tsoy (2020), who use our results to support non-Markov strategies in which the firm is "punished" for exceeding a target leverage ratio by reverting to our MPE.) Naturally, we expect that firms will try to reduce the agency costs resulting from the leverage ratchet effect and capture some of the funding advantages of debt by using alternative commitment mechanisms such as collateral or covenants that restrict future debt issuance.…”