Marc Arnold

Growth Options, Macroeconomic Conditions and the Cross-Section of Credit Risk

This paper develops a structural equilibrium model with intertemporal macroeconomic risk, incorporating the fact that firms are heterogeneous in their asset composition. Compared to firms that are mainly composed of invested assets, firms with growth options have higher costs of debt because they are more volatile and have a greater tendency to default during recession when marginal utility is high and recovery rates are low. Our model matches empirical facts regarding credit spreads, default probabilities, leverage ratios, equity premiums, and investment clustering. Importantly, it also makes predictions about the cross-section of all these features.

Financing Asset Sales and Business Cycles

Using a dynamic model of financing, investment, and macroeconomic risk, we investigate when firms sell assets to fund investments (financing asset sales) across the business cycle. The model reveals that financing asset sales entail a lower wealth transfer from equity to debt than otherwise identical but equity financed investments. Exploring the dynamics of this motive across business cycles helps explain novel stylized facts about asset sales and their business cycle patterns that cannot be rationalized by traditional motives for selling assets.

Online Appendices to Financing Asset Sales and Business Cycles

This document contains the Online Appendices for the paper Financing Asset Sales and Business Cycles. Full paper is available at: http://ssrn.com/abstract=2356377.

Neglected Risk: Evidence from Structured Product Counterparty Exposure

We compare prices of structured products paid by retail investors with prices available to institutional investors for identical payout profiles. The price differences reveal that product issuers do not compensate retail investors for counterparty exposure before the Lehman default. Post-Lehman, retail prices no longer neglect this risk. We also measure retail investor attention towards issuer credit risk. For a given level of issuer credit risk, counterparty exposure is compensated more when attention is higher. Furthermore, issuers tend to construct products with larger counterparty exposure. Overall, our results shed light on the conditions under which financial engineering generates neglected risk.

The Value of Creditor Governance: Debt Renegotiations In and Outside Distress

This paper analyzes a structural model of a levered firm that can renegotiate debt outside and in distress. The firm renegotiates outside distress to waive its financing covenant when raising investment funds and renegotiates in distress to avoid bankruptcy costs. Incorporating the ability to renegotiate both outside and in distress is crucial to explaining timing patterns of debt renegotiations. Capturing realistic incentives and timing patterns of renegotiations allows us to quantify the value of creditor governance. We explain a rich set of empirical facts in terms of influence of renegotiable debt on security values and corporate policies.

Creditor Governance and Corporate Policies: The Role of Debt Covenant Renegotiations

This paper analyzes a structural model of a levered firm that can renegotiate debt outside and in distress. The firm renegotiates outside distress to waive its financing covenant when raising investment funds and renegotiates in distress to avoid bankruptcy costs. Incorporating the ability to renegotiate both outside and in distress is crucial to explaining timing patterns of debt renegotiations. Capturing realistic incentives and timing patterns of renegotiations allows us to quantify the value of creditor governance. We explain a rich set of empirical facts in terms of influence of renegotiable debt on security values and corporate policies.

The Impact of Renegotiable Debt on Firms

This paper analyzes a structural model of a levered firm that can renegotiate debt outside and in distress. The firm renegotiates outside distress to waive its financing covenant when raising investment funds and renegotiates in distress to avoid bankruptcy costs. Incorporating the ability to renegotiate both outside and in distress is crucial to explaining timing patterns of debt renegotiations. Capturing realistic incentives and timing patterns of renegotiations allows us to quantify the value of creditor governance. We explain a rich set of empirical facts in terms of influence of renegotiable debt on security values and corporate policies.