Strategic Behavior, Financing, and Stock Returns

In this paper I analyze how debt structure and the strategic interaction between shareholders and creditors in the event of default a¤ect expected stock returns. By endogenizing shareholders’decision to default, the model generates new predictions linking …rm characteristics to expected stock returns through an intuitive economic mechanism. In particular, the model predicts that expected stock returns are higher for …rms that face high debt renegotiation di¢ culties, and that have a large fraction of secured or convertible debt. Expected stock returns are lower for …rms whose shareholders maintain strong bargaining power, and for …rms subject to high liquidation costs. Using a large sample of publicly traded US …rms 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. Keywords: Debt Structure, Strategic Behavior, Stock Returns, Renegotiation, Default JEL Classi…cation: G13, G32, G33 Swiss Finance Institute, University of Lausanne, Bâtiment Extranef, 1015 Lausanne, Switzerland. Email: [email protected]; Phone: +41 21 692 3399. I thank Erwan Morellec for his constant support and valuable comments. I also thank Jerome Detemple, Darrell Du¢ e, Laurent Frésard, Verónica Garcés, Enrique Schroth, Norman Schürho¤, and seminar participants at the University of Lausanne and at the Swiss Doctoral Workshop 2007 in Gerzensee for valuable comments and suggestions. Any remaining errors are mine.