Title: Optimal debt dynamics, issuance costs, and commitment
Authors: Luca Benzoni - Federal Reserve Bank of Chicago (United States) [presenting]
Lorenzo Garlappi - University of British Columbia (Canada)
Robert Goldstein - University of Minnesota (United States)
Chao Ying - University of Minnesota (United States)
Abstract: Optimal dynamic capital structure policy in the presence of fixed issuance costs is investigated. For each level of issuance costs, including zero, we identify the global-optimal debt policy. Commitment to this optimal policy is credible if debt holders threaten to punish any deviation by forever pricing debt according to the no-commitment policy. However, commitment to debt repurchases is not credible once realistic equity issuance costs are accounted for, providing one explanation for why firms are unable to issue risk-free debt. When calibrated to realistic issuance costs, the no-commitment policy generates almost as much tax benefits to debt as does the optimal policy.