Three Essays on Leverage and Debt Contracts
Author: Hugh Marble
Publisher:
Published: 2007
Total Pages:
ISBN-13:
DOWNLOAD EBOOKABSTRACT: My studies considered three things: (1) the choice between non-recourse secured debt and recourse debt (unsecured debt or secured debt with recourse) by firms that are sequentially acquiring assets and then making investment choices once those assets have been acquired, (2) how secured debt financing impacts both the asset substitution and underinvestment problems, and (3) the frequency with which credit rating changes result from changes in the firm's operating environment versus changes in capital structure controlled by management. First, non-recourse secured debt is shown to be optimal for firms engaged in the acquisition of assets which have little need for non-contractible ongoing investment. Unsecured debt provides superior post-acquisition incentives for owners of assets that require ongoing investment or that can be easily modified. Empirical tests using Real Estate Investment Trusts provide evidence supporting the model and consistent with previous work. Second, the underinvestment problem does not depend on the proportion of the original debt that is secured and the asset substitution problem decreases in the proportion of the original debt that is secured. Debt capacity increases with the proportion of debt that is secured as the asset substitution problem is lower for a given level of debt. An analysis of a large sample of firms with COMPUSTAT data supports the model predictions. Third, I found that management action plays a significant role in credit rating changes. Twenty-four percent of downgrades and 41% of upgrades have a substantial management influence. The frequency of management impact on credit ratings shows the limitations of credit risk modeling using structural models that assume constant capital structure.