The Leverage Ratchet Effect

Anat Admati, Peter DeMarzo, Martin Hellwig and Paul Pfleiderer

Journal of Finance, 2018, vol. 73, issue 1, 145-198

Abstract: Firms’ inability to commit to future funding choices has profound consequences for capital structure dynamics. With debt in place, shareholders pervasively resist leverage reductions no matter how much such reductions may enhance firm value. Shareholders would instead choose to increase leverage even if the new debt is junior and would reduce firm value. These asymmetric forces in leverage adjustments, which we call the leverage ratchet effect, cause equilibrium leverage outcomes to be history†dependent. If forced to reduce leverage, shareholders are biased toward selling assets relative to potentially more efficient alternatives such as pure recapitalizations.

Date: 2018
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Citations: View citations in EconPapers (100)

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https://doi.org/10.1111/jofi.12588

Related works:
Working Paper: The Leverage Ratchet Effect (2017)
Working Paper: The Leverage Ratchet Effect (2017)
Working Paper: The Leverage Ratchet Effect (2015)
Working Paper: The Leverage Ratchet Effect (2013)
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