Does Performance-Sensitive Debt mitigate Debt Overhang?

AbstractPrior studies argue that investment by undervalued firms that require external equity is particularly sensitive to stock prices in irrational capital markets. We present a model in which investment can appear to be more sensitive to stock prices when capital markets are rational, but subject to imperfections such as debt overhang, information asymmetries, and financial distress costs. Our empirical tests support the rational (but imperfect) capital markets view. Specifically, investment–stock price sensitivity is related to firm leverage, financial slack, and probability of financial distress, but is not related to proxies for firm undervaluation. Because, in our model, stock prices reflect the net present values (NPVs) of investment opportunities, our results are consistent with rational capital markets improving the allocation of capital by channeling more funds to firms with positive NPV projects.

Download Full-text

Contingent Capital: The Case of COERCs

Journal of Financial and Quantitative Analysis ◽

10.1017/s0022109014000398 ◽

2014 ◽

Vol 49 (3) ◽

pp. 541-574 ◽

Cited By ~ 62

Author(s):

George Pennacchi ◽

Theo Vermaelen ◽

Christian C. P. Wolff

Keyword(s):

Moral Hazard ◽

Market Value ◽

Low Risk ◽

Call Option ◽

Debt Overhang ◽

Contingent Capital ◽

New Form ◽

Government Bailouts

AbstractThis paper introduces and analyzes a new form of contingent convertible: a call option enhanced reverse convertible (COERC). If an issuing bank’s market value of capital breaches a trigger, COERCs convert to many new equity shares that would heavily dilute existing shareholders, except that shareholders have the option to purchase these shares at the bond’s par value. COERCs have low risk: They are almost always fully repaid in cash. Yet, they reduce government bailouts by replenishing a bank’s capital. COERCs’ design also avoids problems with market-value triggers, such as manipulation or panic, while reducing moral hazard and debt overhang.

Download Full-text

A Theory of Debt Maturity: The Long and Short of Debt Overhang

SSRN Electronic Journal ◽

10.2139/ssrn.1539650 ◽

2012 ◽

Cited By ~ 4

Author(s):

Douglas W. Diamond ◽

Zhiguo He

Keyword(s):

Debt Maturity ◽

Debt Overhang

Download Full-text

The Debt Overhang Hypothesis: Evidence from Pakistan

Studies in Business and Economics ◽

10.1515/sbe-2016-0012 ◽

2016 ◽

Vol 11 (1) ◽

pp. 140-151 ◽

Cited By ~ 2

Author(s):

Muhammad Imran Shah ◽

Irfan Ullah ◽

Zia Ur Rahman ◽

Nadeem Jan

Keyword(s):

Economic Growth ◽

Dynamic Behaviour ◽

Negative Impact ◽

Labour Force ◽

External Debt ◽

Unit Roots ◽

Debt Overhang ◽

Debt Burden ◽

Long Run ◽

Domestic Labour

AbstractThis study investigates the debt overhang hypothesis for Pakistan in the period 1960-2007. The study examines empirically the dynamic behaviour of GDP, debt services, the employed labour force and investment using the time series concepts of unit roots, cointegration, error correlation and causality. Our findings suggest that debt-servicing has a negative impact on the productivity of both labour and capital, and that in turn has adversely affected economic growth. By severely constraining the ability of the country to service debt, this lends support to the debt-overhang hypothesis in Pakistan. The long run relation between debt services and economic growth implies that future increases in output will drain away in form of high debt service payments to lender country as external debt acts like a tax on output. More specifically, foreign creditors will benefit more from the rise in productivity than will domestic producers and labour. This suggests that domestic labour and capital are the ultimate losers from this heavy debt burden.

Download Full-text

Corporate Debt Overhang and Credit Policy

Brookings Papers on Economic Activity ◽

10.1353/eca.2020.0014 ◽

2020 ◽

Vol 2020 (2) ◽

pp. 447-502

Author(s):

Markus Brunnermeier ◽

Arvind Krishnamurthy

Keyword(s):

Corporate Debt ◽

Credit Policy ◽

Debt Overhang

Download Full-text

Household Debt Overhang Did Hardly Cause a Larger Spending Fall During the Financial Crisis in the UK

SSRN Electronic Journal ◽

10.2139/ssrn.3847551 ◽

2021 ◽

Author(s):

Lars E.O. Svensson

Keyword(s):

Financial Crisis ◽

Household Debt ◽

Debt Overhang ◽

The Uk

Download Full-text

Inequality Overhang: A Heterogeneous Approach

Journal of Income Distribution ◽

10.25071/1874-6322.40428 ◽

2019 ◽

pp. 106-133

Author(s):

Francesco Grigoli ◽

Adrian Robles

Keyword(s):

Economic Development ◽

Income Inequality ◽

Shock Absorber ◽

Negative Impact ◽

Empirical Literature ◽

Debt Overhang ◽

Positive Side ◽

Low Levels ◽

The Relationship ◽

Income Concentration

The linearity of the relationship between income inequality and economic development has been long questioned. While theory provides arguments for which the shape of the relationship may be positive for low levels of inequality and negative for high ones, most of the empirical literature assumes a linear specification finding conflicting results. Employing an innovative empirical approach, robust to endogeneity, we find pervasive evidence of nonlinearities. In particular, similar to the debt-overhang literature, we identify an inequality-overhang level, in that the slope of the relationship between income inequality and economic development switches from positive to negative at a net Gini coefficient of about 27 per cent. We also find that in an environment characterized by widespread financial inclusion and high income concentration, rising income inequality has a larger negative impact on economic development because banks may curtail credit to customers at the lower end of the income distribution. On the positive side, a sufficiently high female labor participation can act as a shock absorber reducing such a negative impact, possibly through a more efficient allocation of resources.

Download Full-text