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Taxation, agency conflicts, and the choice between callable and convertible bonds

Journal

Journal of Economic Theory

Subject

Finance

Publishing details

Journal of Economic Theory 2008 November Vol 143:1 p 374-404

Authors / Editors

Hennessy C;Tserlukevich Y

Biographies

Christopher Hennessy

Publication Year

2008

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.

Keywords

pital structure; Agency; Stochastic differential games

Available on ECCH

No


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