Leverage and Interest Rates

Giovanna Nicodano and Luca Regis

Carlo Alberto Notebooks from Collegio Carlo Alberto

Abstract: We study the sensitivity of optimal leverage to the level of the risk-free interest rate. Our trade-off model implies a heterogeneous response depending on the presence of a sponsor backing company debt. A highly-leveraged, backed company optimally increases debt when interest rates fall, while a company without a sponsor reduces it despite having lower initial leverage. This heterogeneity implies divergent bankruptcy probability and recovery-upondefault, in the same interest rate scenarios, for the two company types. We also show that a lower risk-free rate reduces the sponsor’s incentive to issue debt.

Keywords: capital structure; tax-bankruptcy trade-off; default; LBO; subsidiaries; securitization; restructurings; risk transfer (search for similar items in EconPapers)
Pages: 35 pages
Date: 2023
New Economics Papers: this item is included in nep-ban, nep-cfn and nep-fmk
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Persistent link: https://EconPapers.repec.org/RePEc:cca:wpaper:692

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