Abstract
We analyze debt choice in light of taxes and moral hazard. The model features an infinite sequence of nonzero-sum stochastic differential games between equity and debt. Closed-form expressions are derived for all contingent-claims. If equity can increase volatility without reducing asset drift, callable bonds with call premia are optimal. Although callable bonds induce risk shifting, call premia precommit equity to less frequent restructuring and are tax-advantaged. Convertible bonds mitigate risk shifting, but only induce hedging if assets are far from the default threshold. Convertibles are optimal only if risk shifting reduces asset drift sufficiently.
Original language | English (US) |
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Pages (from-to) | 374-404 |
Number of pages | 31 |
Journal | Journal of Economic Theory |
Volume | 143 |
Issue number | 1 |
DOIs | |
State | Published - Nov 1 2008 |
Externally published | Yes |
Keywords
- Agency
- Capital structure
- Stochastic differential games
ASJC Scopus subject areas
- Economics and Econometrics