Previous studies document that the spread between the yield on commonly used corporate bond indexes (e.g., Moody’s Baa index) and a comparable maturity treasury bond exhibits mean reversion. An analytical model shows that a part of the observed negative relationship between changes in the spread and the level of spreads is a natural consequence of ratings based classification of bonds included in the index and the related effects of survival. Using data on individual corporate bonds over the period January 1985 to December 1996, I corroborate the analysis and illustrate the effects of survival. The result has several implications for parametric specifications of spread dynamics in the pricing of contingent claims, for the application of spreads in tests of asset pricing models (such as the conditional version of the CAPM) and for the use of spreads in business cycle forecasts.

Recent corporate debt offerings have included a covenant specifying a pre-determined payment to debtholders when the debt is downgraded. We examine the incentive for equityholders to increase firm risk (and the associated costs) when debt includes a “rating trigger.” Equityholders of firms with a low-risk profile and operating flexibility choose debt with a trigger, while equityholders of firms with a high-risk profile and less flexibility choose regular debt. A trigger that requires an equity infusion better mitigates conflicts between equityholders and debtholders than a trigger paid by liquidating assets. A trigger that increases the coupon rate is not optimal.

We show how the structure of partner incentives and decision processes within a venture capital firm contribute to fund performance and partnership success. Optimal capital allocation during staged financing requires that partner incentives encourage cooperation by linking a partner's compensation to the return on the entire fund rather than return on the investment sponsored by an individual partner. Incentives for individual performance are optimally provisioned by a higher profit share in a subsequent fund. Our paper provides an economic underpinning to empirical observations about partner pay and the internal organization of venture capital firms.

We examine the impact of changes in Greek sovereign yield spreads on abnormal returns of financial sector stocks for a sample of Eurozone countries, during the Greek debt crisis. We find that increases in yield spreads are associated with negative abnormal returns on financial stocks in the Portugal, Spain and Netherlands. These abnormal returns are driven in part by ratings downgrades and other unfavorable news announcements about Greece. We isolate the effects of known transmission channels–impairment of financial firms’ asset base due to cross-holdings of Greek bonds, from increases in domestic interest rates and higher funding costs. Our analysis indicates that news events lead to spillovers in excess of what can be explained by these channels of transmission.

Using an earnings-based structural model, calibrated with US data for the period 2001–2017, we examine how the structure of an interest expense cap for the deduction of interest expense changes the tax benefits of debt. We find that an EBIT (EBITDA) based cap reduces the marginal tax benefits of debt by 6 percentage points (4.6 p.p.) of unlevered firm value for a typical firm. This impact differs across industries due to variations in industry-specific labor and physical capital deployed, and the associated depreciation. An EBITDA-based structure for a cap reduces the differential tax impact of a cap across industries. Our results are widely applicable in determining the cost of debt in the presence of these cap structures, enshrined in the US and OECD countries.