Optimal Debt Dynamics, Issuance Costs, and Commitment

Benzoni, Luca; Garlappi, Lorenzo; Goldstein, Robert S.; Hugonnier, Julien; Ying, Chao

doi:10.21033/wp-2020-20

Working Paper

Optimal Debt Dynamics, Issuance Costs, and Commitment

Abstract: We investigate optimal capital structure and debt maturity policies in the presence of fixed issuance costs. We identify the global-optimal policy that generates the highest values of equity across all states of nature consistent with limited liability. The optimal policy without commitment provides almost as much tax benefits to debt as does the global-optimal policy and, in the limit of vanishing issuance costs, allows firms to extract 100% of EBIT. This limiting case does not converge to the equilibrium of DeMarzo and He (2019), who report no tax benefits to debt when issuance costs are set to zero at the outset.

Keywords: Capital Structure; Bankruptcy; Issuance Costs; Commitment; Coase Conjecture; Credit Spreads; Asset Pricing; Trading Volume; Bond Interest Rates; Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill; Liquidation;