Corporate Debt Value, Bond Covenants, and Optimal Capital Structure
Hayne Leland, University of California at Berkeley

Hayne produced two papers in connection with this project.

The first paper, “Corporate Debt Value, Bond Covenants, and Optimal Capital Structure,” examines corporate debt values and capital structure in a unified analytical framework. The paper derives closed-form results for the value of long-term risky debt and yield spreads, for optimal capital structure. The results are attractive because neither debt values nor capital structure can be fully understood in isolation. The results will help us to better understand how to value junk bonds and why firms would choose to issue junk bonds instead of investment grade debt.

The second paper, “Bond Prices, Yield Spreads, and Optimal Capital Structure with Default Risk,” extends the previous work to include debt of arbitrary maturity. (The methods used in the former paper could only examine very short term debt or infinitely lived debt.) The work thus extends Merton’s results on zero coupon bonds to bonds that pay coupons. (Accepted Fall 1995.)