Template-Type: ReDIF-Paper 1.0

Author-Name: Dirk Hackbarth
Author-X-Name-First: Dirk
Author-X-Name-Last: Hackbarth
Author-Email: hackbarth@olin.wustl.edu
Author-Workplace-Name: Finance Department, Olin School of Business, 
Washington University in St. Louis

Author-Name: Junjian Miao
Author-X-Name-First: Junjian
Author-X-Name-Last: Miao
Author-Email: miaoj@bu.edu
Author-Workplace-Name: Department of Economics, Boston University

Author-Name: Erwan Morellec
Author-X-Name-First: Erwan
Author-X-Name-Last: Morellec
Author-Email: erwan.morellec@unil.ch
Author-Workplace-Name: University of Lausanne, FAME, and CEPR

Title: Capital Structure, Credit Risk, and Macroeconomic Conditions

Abstract: This paper develops a framework for analyzing the impact of macroeconomic conditions
on credit risk and dynamic capital structure choice. We begin by observing that when
cash flows depend on current economic conditions, there will be a benefit for firms
to adapt their default and financing policies to the position of the economy in the
business cycle phase. We then demonstrate that this simple observation has a wide
range of empirical implications for corporations. Notably, we show that our model can
replicate observed debt levels and the countercyclicality of leverage ratios. We also
demonstrate that it can reproduce the observed term structure of credit spreads and
generate strictly positive credit spreads for debt contracts with very short maturities.
Finally, we characterize the impact of macroeconomic conditions on the pace and size
of capital structure changes, and debt capacity.

Length: 40 pages
Creation-Date: 2005-11
Revision-Date: 
Publication-Status: Forthcoming in Journal of Financial Economics
File-URL: http://people.bu.edu/miaoj/business.pdf
File-Format: Application/pdf
File-Function: 
Number: WP2005-005
Classification-JEL: G12, G32, G33
Keywords: Dynamic capital structure; Credit spreads; Macroeconomic conditions
Handle: RePEc:bos:macppr:WP2005-005