Strategic Behavior, Financing, and Stock Returns

http://69.175.2.130/~finman/Prague/Papers/strategic_returns.pdfWorking Paper, Swiss Finance Institute, University of LausanneIn this paper I analyze how debt structure and the strategic interaction between shareholders and creditors in the event of default affect expected stock returns. By endogenizing shareholders' decision to default, the model generates new predictions linking firm characteristics to expected stock returns through an intuitive economic mechanism. In particular, the model predicts that expected stock returns are higher for firms that face high debt renegotiation difficulties, and that have a large fraction of secured or convertible debt. Expected stock returns are lower for firms whose shareholders maintain strong bargaining power, and for firms subject to high liquidation costs. Using a large sample of publicly traded US firms between 1985 and 2005, I present new evidence on the link between debt structure, renegotiation frictions, and stock returns, which is supportive of the model's predictions