The Hazards of Debt: Rollover Freezes, Incentives, and Bailouts
By Ing-Haw Cheng, Konstantin W. Milbradt. 2012
134 citations recorded by the source corpus.
We investigate the trade-off between incentive provision and inefficient rollover freezes for a firm financed with short-term debt. First, debt maturity that is too short-term is inefficient, even with incentive provision. The optimal maturity is an interior solution that avoids excessive rollover risk while providing sufficient incentives for the manager to avoid risk-shifting when the firm is in good health. Second, allowing the manager to risk-shift during a freeze actually increases creditor confidence. Debt policy should not prevent the manager from holding what may appear to be otherwise low-mean strategies that have option value during a freeze. Third, a limited but not perfectly reliable form of emergency financing during a freeze--a "bailout"--may improve the terms of the trade-off and increase total ex ante value by instilling confidence in the creditor markets. Our conclusions highlight the endogenous interaction between risk from the asset and liability sides of the balance sheet. The Author 2011. Published by Oxford University Press on behalf of The Society for Financial Studies. All rights reserved. For Permissions, please e-mail: journals.permissions@oup.com., Oxford University Press.
Subfields: Economics and Econometrics, Finance
View Paper: https://www.semanticscholar.org/paper/ed14b7989388ac74f258f26447562ef92bd67c7d
How researchers see this paper
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In Economics and Econometrics
- Martin Oehmke
- Markus K. Brunnermeier
- Arvind Krishnamurthy
- Nicholas Barberis
- Zhiguo He
- Peter Feldhütter
- Marcel Fratzscher
- Lasse Heje Pedersen
In Finance
- Martin Oehmke
- Markus K. Brunnermeier
- Arvind Krishnamurthy
- Zhiguo He
- Peter Feldhütter
- Marcel Fratzscher
- Lasse Heje Pedersen
- Saki Bigio
Citations in the corpus
- The Maturity Rat Race (2013, background): “In particular, as demonstrated in Diamond (1993) (for corporate debt) and Bolton and Jeanne (2009) (for sovereign debt), allowing for some for of ex-post dilution may be optimal in order to overcome debt overhang problems that may arise once initial nancing is in place.”
- Quantifying Liquidity and Default Risks of Corporate Bonds over the Business Cycle (2018, unknown): “(7)Models analyze these issues include, for example, Berk and Green (2004), He and Xiong (2012a), Cheng and Milbradt (2012), and Suarez, Schroth, and Taylor (2014).”
- Safer Ratios, Riskier Portfolios: Banks’ Response to Government Aid (2014, unknown): “5 Cheng and Milbradt (2012) further show that a bailout policy may play an important role in instilling confidence in creditor markets and preventing credit freezes.”