Optimal capital structure and endogenous default (Q1849796)

The authors study a firm where the value of assets evolves as a diffusion until falling below some critical bankruptcy level. The firm is partly financed by debt whose maturity profile is maintained constant through time, by the simultaneous issuance of new debt and retirement of old. This debt is of equal seniority and attracts coupons at a fixed rate. Additionally, the firm receives tax benefits on the coupon payments to bondholders. The shareholders set the bankruptcy level so as to maximize the value of the firm equity under the constraints that the value of equity must remain non-negative at all times and that the firm assets may not be sold off to pay coupons. The value of the firm assets are supposed to make downward jumps. The value of the firm and the value of its debt have no closed form expression, but some transforms are found which can be inverted numerically.