Corporate Leverage and Currency Crises

Arturo Bris () and Yrjö Koskinen ()
Additional contact information
Arturo Bris: Yale School of Management, Postal: 135 Prospect Street, New Haven CT 06511-3729, U.S.A.

No 367, SSE/EFI Working Paper Series in Economics and Finance from Stockholm School of Economics

Abstract: This paper provides an explanation of currency crises based on an argument that bailing out financially distressed exporting firms through a currency depreciation is ex-post optimal. Exporting firms have profitable investment opportunities, but they will not invest because high leverage causes debt overhang problems. The government can make investments feasible by not defending a fixed exchange rate and letting the currency depreciate. Currency depreciation always increases the profitability of new investments when revenues are in a foreign currency and costs are at least partially in domestic. Interestingly, foreign borrowing by exporting firms doesn't change the qualitative results: if firms' debt is denominated in foreign currency, a larger depreciation is needed to restore incentives to invest. An important feature in our model is that in general exporting firms choose to finance investments with debt instead of equity. Currency depreciation is socially optimal if risky projects have a higher expected return than safe projects and if firms are forced to rely on debt financing because of underdeveloped equity markets. Although currency depreciation is always ex-post optimal, it can be harmful ex-ante. Exporting firms know that the government will let the currency depreciate, if their risky investments have failed. This leads to excessive investment in risky projects even if more valuable safe projects are available.

Keywords: Currency depreciation; debt overhang; emerging markets; efficient investment policy; excessive risk taking (search for similar items in EconPapers)
JEL-codes: F34 G15 G31 G32 (search for similar items in EconPapers)
Pages: 33 pages
Date: 2000-03-17, Revised 2001-07-02
New Economics Papers: this item is included in nep-cfn, nep-fin, nep-fmk and nep-ifn
References: View references in EconPapers View complete reference list from CitEc
Citations: View citations in EconPapers (4)

Published in Journal of Financial Economics, 2002, pages 275-310.

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http://swopec.hhs.se/hastef/papers/hastef0367.pdf (application/pdf)

Related works:
Working Paper: Corporate Leverage And Currency Crises (2008)
Journal Article: Corporate leverage and currency crises (2002)
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Persistent link: https://EconPapers.repec.org/RePEc:hhs:hastef:0367

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