The Journal of Finance

Corporate Debt Value, Bond Covenants, and Optimal Capital Structure

Published: 09/01/1994   |   DOI: 10.1111/j.1540-6261.1994.tb02452.x

HAYNE E. LELAND

This article examines corporate debt values and capital structure in a unified analytical framework. It derives closed‐form results for the value of long‐term risky debt and yield spreads, and for optimal capital structure, when firm asset value follows a diffusion process with constant volatility. Debt values and optimal leverage are explicitly linked to firm risk, taxes, bankruptcy costs, risk‐free interest rates, payout rates, and bond covenants. The results elucidate the different behavior of junk bonds versus investment‐grade bonds, and aspects of asset substitution, debt repurchase, and debt renegotiation.

Financial Synergies and the Optimal Scope of the Firm: Implications for Mergers, Spinoffs, and Structured Finance

Published: 03/20/2007   |   DOI: 10.1111/j.1540-6261.2007.01223.x

HAYNE E. LELAND

Multiple activities may be separated financially, allowing each to optimize its financial structure, or combined in a firm with a single optimal financial structure. We consider activities with nonsynergistic operational cash flows, and examine the purely financial benefits of separation versus merger. The magnitude of financial synergies depends upon tax rates, default costs, relative size, and the riskiness and correlation of cash flows. Contrary to accepted wisdom, financial synergies from mergers can be negative if firms have quite different risks or default costs. The results provide a rationale for structured finance techniques such as asset securitization and project finance.

DYNAMIC PORTFOLIO THEORY*

Published: 06/01/1969   |   DOI: 10.1111/j.1540-6261.1969.tb00376.x

Hayne E. Leland

Who Should Buy Portfolio Insurance?

Published: 05/01/1980   |   DOI: 10.1111/j.1540-6261.1980.tb02190.x

HAYNE E. LELAND

Option Pricing and Replication with Transactions Costs

Published: 12/01/1985   |   DOI: 10.1111/j.1540-6261.1985.tb02383.x

HAYNE E. LELAND

Transactions costs invalidate the Black‐Scholes arbitrage argument for option pricing, since continuous revision implies infinite trading. Discrete revision using Black‐Scholes deltas generates errors which are correlated with the market, and do not approach zero with more frequent revision when transactions costs are included. This paper develops a modified option replicating strategy which depends on the size of transactions costs and the frequency of revision. Hedging errors are uncorrelated with the market and approach zero with more frequent revision. The technique permits calculation of the transactions costs of option replication and provides bounds on option prices.

Agency Costs, Risk Management, and Capital Structure

Published: 12/17/2002   |   DOI: 10.1111/0022-1082.00051

Hayne E. Leland

The joint determination of capital structure and investment risk is examined. Optimal capital structure reflects both the tax advantages of debt less default costs (Modigliani and Miller (1958, 1963)), and the agency costs resulting from asset substitution (Jensen and Meckling (1976)). Agency costs restrict leverage and debt maturity and increase yield spreads, but their importance is small for the range of environments considered.

Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads

Published: 07/01/1996   |   DOI: 10.1111/j.1540-6261.1996.tb02714.x

HAYNE E. LELAND, KLAUS BJERRE TOFT

This article examines the optimal capital structure of a firm that can choose both the amount and maturity of its debt. Bankruptcy is determined endogenously rather than by the imposition of a positive net worth condition or by a cash flow constraint. The results extend Leland's (1994a) closed‐form results to a much richer class of possible debt structures and permit study of the optimal maturity of debt as well as the optimal amount of debt. The model predicts leverage, credit spreads, default rates, and writedowns, which accord quite closely with historical averages. While short term debt does not exploit tax benefits as completely as long term debt, it is more likely to provide incentive compatibility between debt holders and equity holders. Short term debt reduces or eliminates “asset substitution” agency costs. The tax advantage of debt must be balanced against bankruptcy and agency costs in determining the optimal maturity of the capital structure. The model predicts differently shaped term structures of credit spreads for different levels of risk. These term structures are similar to those found empirically by Sarig and Warga (1989). Our results have important implications for bond portfolio management. In general, Macaulay duration dramatically overstates true duration of risky debt, which may be negative for “junk” bonds. Furthermore, the “convexity” of bond prices can become “concavity.”

INFORMATIONAL ASYMMETRIES, FINANCIAL STRUCTURE, AND FINANCIAL INTERMEDIATION

Published: 05/01/1977   |   DOI: 10.1111/j.1540-6261.1977.tb03277.x

Richard Brealey, Hayne E. Leland, David H. Pyle

Symposium on Public Policy Issues in Finance

Published: 04/18/2012   |   DOI: 10.1111/j.1540-6261.1997.tb02729.x

HAYNE E. LELAND, MARTIN FELDSTEIN, ROBERT R. GLAUBER, DAVID W. MULLINS, STEVEN M. H. WALLMAN

The thesis of this symposium, organized by James Bicksler, was that while finance theory will surely inform practitioners, it seems appropriate to pay some attention to the opposite flow: practitioners can inform theory. Contributors include a distinguished group of practitioners with extensive backgrounds in economics, and economists with extensive public policy experience: Martin Feldstein, Robert Glauber, David Mullins, and Steven Wallman. Their topics range from privatizing social security, to managing market crashes, to the regulatory agency cost problem, to regulatory constraints in a technologically advanced world.