Leverage Choice and Credit Spreads when Managers Risk Shift

Ali Lazrak and Murray Carlson
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Ali Lazrak: GREGH - Groupement de Recherche et d'Etudes en Gestion à HEC - HEC Paris - Ecole des Hautes Etudes Commerciales - CNRS - Centre National de la Recherche Scientifique

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Abstract: We model the debt and asset risk choice of a manager with performance-insensitive pay (cash) and performance-sensitive pay (stock) to theoretically link compensation structure, leverage, and credit spreads. The model predicts that optimal leverage trades off the tax benefit of debt against the utility cost of ex-post asset substitution and that credit spreads are increasing in the ratio of cash-to-stock. Using a large cross-section of U.S.-based corporate credit default swaps (CDS) covering 2001 to 2006, we find a positive association between cash-to-stock and CDS rates, and between cash-to-stock and leverage ratios.

Keywords: Leverage Choice; Credit Spreads; Managers; Risk (search for similar items in EconPapers)
Date: 2010-12
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Citations: View citations in EconPapers (28)

Published in The Journal of Finance, 2010, 65 (6), pp.2323-2362. ⟨10.1111/j.1540-6261.2010.01617.x⟩

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Persistent link: https://EconPapers.repec.org/RePEc:hal:journl:hal-00585953

DOI: 10.1111/j.1540-6261.2010.01617.x

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