CORPORATE-DEBT VALUE, BOND COVENANTS, AND OPTIMAL CAPITAL STRUCTURE

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 capit al structure, when firm asset value follows a diffusion process with c onstant volatility. Debt values and optimal leverage are explicitly li nked 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 a sset substitution, debt repurchase, and debt renegotiation.