We study the implications of imperfect information for term structures of credit spreads on corporate bonds. We suppose that bond investors cannot observe the issuer’s assets directly, and receive instead only periodic and imperfect accounting reports. For a setting in which the assets of the firm are a geometric Brownian motion until informed equityholders optimally liquidate, we derive the conditional distribution of the assets, given accounting data and survivorship. Contrary to the perfect-information case, there exists a default-arrival intensity process. That intensity is calculated in terms of the conditional distribution of assets. Credit yield spreads are characterized in terms of accounting information. Generalizations are provided.

This paper empirically tests five structural models of corporate bond pricing: those of Merton (1974), Geske (1977), Leland and Toft (1996), Longsta# and Schwartz (1995), and Collin-Dufresne and Goldstein (2001). We implement the models using a sample of 182 bond prices from firms with simple capital structures during the period 1986-1997. The conventional wisdom is that structural models do not generate spreads as high as those seen in the bond market, and true to expectations we find that the predicted spreads in our implementation of the Merton model are too low. However, most of the other structural models predict spreads that are too high on average. Nevertheless, accuracy is a problem, as the newer models tend to severely overstate the credit risk of firms with high leverage or volatility and yet su#er from a spread underprediction problem with safer bonds. The Leland and Toft model is an exception in that it overpredicts spreads on most bonds, particularly those with high coupons. More accurate structural models must avoid features that increase the credit risk on the riskier bonds while scarcely a#ecting the spreads of the safest bonds.

Abstract not found

In the presence of frictions, firms adjust their capital structure infrequently. As a consequence, in a dynamic economy the leverage of most firms is likely to differ from the “optimum ” leverage at the time of readjustment. This paper explores the empirical implications of this observation. I use a calibrated dynamic trade-off model to simulate firms ’ capital structure paths. The results of standard cross-sectional tests on these data are consistent with those reported in the empirical literature. In particular, the standard interpretation of some test results leads to the rejection of the underlying model. Taken together, the results suggest a rethinking of the way capital structure tests are conducted. RECENT EMPIRICAL RESEARCH IN CAPITAL STRUCTURE focuses on regularities in the cross section of leverage to discriminate between various theories of financing policy. In this research, book and market leverage are related to profitabil-ity, book-to-market, and firm size. Changes in market leverage are largely ex-plained by changes in equity value. Past book-to-market ratios predict current

This paper provides new evidence of how macroeconomic conditions affect capital structure choice. We model firms ’ target capital structures as a function of macroeconomic conditions and firm-specific variables. We split our sample based on a measure of financial constraints. We find that target leverage is counter-cyclical for the relativelyunconstrained sample, but pro-cyclical for the relativelyconstrained sample. The choice of what type of security to issue/repurchase is significantly related to deviations from the target capital structure, particularly for the constrained sample. Macroeconomic conditions are significant for issue choice for unconstrained firms but less so for constrained firms. Our results support the hypothesis that unconstrained firms are able to time their issue choice to periods when macroeconomic conditions are favorable, while constrained firms take what they can get.

There are two tax incentives for corporations to hedge: to increase debt capacity and interest tax deductions, and to reduce expected tax liability if the tax function is convex. We test whether these incentives affect the extent of corporate hedging with derivatives. Using an explicit measure of tax function convexity, we find no evidence that firms hedge in response to tax convexity. Our analysis does, however, indicate that firms hedge to increase debt capacity, with increased tax benefits averaging 1.1 percent of firm value. Our results also indicate that firms hedge because of expected financial distress costs and firm size.

Cochrane, in particular, gave me the best paper comments I have received in my career. Gerard Hoberg provided terrific research assistance. The author’s current web page is

Investors demand high risk premia for defaultable claims, because (i) defaults tend to concentrate in bad times when marginal utility is high; (ii) default losses are high during such times. I build a structural model of financing and default decisions in an economy with business-cycle variations in expected growth rates and volatility, which endogenously generate countercyclical comovements in risk prices, default probabilities, and default losses. Credit risk premia in the calibrated model not only can quantitatively account for the high corporate bond yield spreads and low leverage ratios in the data, but have rich implications for firms’ financing decisions.

Abstract not found

Philadelphia for their comments on previous versions of this paper. Empirical Evidence on the Relation Between