Capital Structure (Leverage)
Friday, Jan. 4, 2019 8:00 AM - 10:00 AM
- Chair: Michael Roberts, University of Pennsylvania
Capital Structure and Hedging Demand with Incomplete Markets
AbstractCapital structure choices are the result of supply considerations, such as taxes, costly default, agency, and asymmetric information, as well as demand factors, among which investors' hedging demand. The latter, which has received very little attention in the academic literature, is at the core of this paper. In a general equilibrium model with production and incomplete markets where households differ in their risk--sharing needs, ex--ante identical value--maximizing firms issue different securities, in order to cater to different groups of investors. We find that as the demand for hedging increases, corporates grow in size -- to allow for greater precautionary saving -- and issue more debt. How much more, depends on the availability of competing risk-sharing instruments, such as (government--issued) risk--free debt and derivatives. When capital structure is jointly shaped by demand and supply considerations -- the latter, in the form of an asset--substitution problem -- we find that (i) agency is relevant only when hedging demand is high and that (ii) larger investors' risk--sharing needs lead to equilibria featuring greater aggregate risk.
The Maturity Premium
AbstractWe analyze asset-pricing implications of debt maturity. Firms with long debt maturities have weaker incentives to delever after negative shocks and therefore exhibit high leverage and high betas during downturns when the market price of risk is high. They also increase leverage less aggressively during booms. Thus, the betas of firms with longer debt maturities covary more with the market price of risk. As a result, they generate higher expected returns, controlling for average exposure to systematic risk. We demonstrate this in a model and document empirically a 0.21% monthly premium for buying long-maturity financed firms and selling those with shorter debt maturities.
- G3 - Corporate Finance and Governance