Gunnar Grass

Does Conglomeration Really Reduce Credit Risk

I quantify the effects of conglomeration on credit risk by first computing theoretical default probabilities for conglomerates and their hypothetical stand‐alone counterparts and then mapping them into physical probabilities using a comprehensive database of corporate failures. Comparing the credit risk of conglomerates with that of hypothetical stand‐alone firms, I report significant reductions in the annual probability of default for small firms. My results support the proposition that managers can have a strong incentive to engage in conglomeration, even if it reduces shareholder value and show for which firms this is the case.

Extracting Credit Spreads from Structural Models Via the Payout Ratio

I introduce a new way to imply credit spreads from structural models. The proposed measure, CS_POR, is extracted via the payout ratio as the increase in continuous interest payments to creditors necessary to offset the impact of an increase in asset variance on the option value of debt. I derive CS_POR for the Merton (1974) model of capital structure and use it in an empirical setting to explain variations in the spreads of (i) corporate bonds and (ii) credit default swaps. My measure clearly outperforms its benchmark and even beats predictors from a powerful reduced-form model.