Leverage ratchet effect

Bank leverage, welfare, and regulation.

Other versions of this item: Anat R. Admati, Anat R. Nyborg, Discussion Papers. Douglas W. Strebulaev, Ilya A. Kenneth R.

Leverage ratchet effect

We analyze equilibrium leverage dynamics in a dynamic tradeoff model when the firm is unable to commit to a leverage policy ex ante. We develop a methodology to characterize equilibrium equity and debt prices in a general jump-diffusion framework, and apply our approach to the standard Leland setting. Absent commitment, the leverage ratchet effect Admati et al. On the other hand, countervailing effects of asset growth and debt maturity cause leverage to mean-revert towards a long run target. In equilibrium, bond investors anticipate future leverage increases and require significant credit spreads even when the distance to default is large. As a result, the tax benefits of future debt increases are fully dissipated, and equilibrium equity values match those in a model where the firm commits not to issue new debt. Despite the absence of transactions costs, an increase in profitability causes leverage to decline in the short-run, but the rate of new debt issuance endogenously increases so that leverage ultimately mean-reverts. The target level of leverage, and the speed of adjustment depends critically on debt maturity; nonetheless, in equilibrium shareholders are indifferent toward the debt maturity structure. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research. Download Citation Data. Peter M. Share X LinkedIn Email. Working Paper

On the other hand, countervailing effects of asset growth and debt maturity cause leverage to mean-revert towards a long run target. I need help.

Use limited data to select advertising. Create profiles for personalised advertising. Use profiles to select personalised advertising. Create profiles to personalise content. Use profiles to select personalised content.

A ratchet is any mechanism that allows progressive movement in one direction. Named after the ratcheting form of a winch, the ratchet effect applies to any process where progress is difficult to reverse. The ratchet effect is a cycle of events. For a large force, event, or economic process to occur, it requires that the direction of progress is dependent on the changes in the previous cycle. Once set in motion it is difficult to reverse.

Leverage ratchet effect

A ratchet effect is an instance of the restrained ability of human processes to be reversed once a specific thing has happened, analogous with the mechanical ratchet that holds the spring tight as a clock is wound up. It is related to the phenomena of featuritis and scope creep in the manufacture of various consumer goods, and of mission creep in military planning. In sociology, "ratchet effects refer to the tendency for central controllers to base next year's targets on last year's performance, meaning that managers who expect still to be in place in the next target period have a perverse incentive not to exceed targets even if they could easily do so". Garrett Hardin , a biologist and environmentalist, used the phrase to describe how food aid keeps people alive who would otherwise die in a famine. They live and multiply in better times, making another bigger crisis inevitable, since the supply of food has not been increased. Peacock and Wiseman found that public spending increases like a ratchet following periods of crisis. Jean Tirole used the concept in his pioneering work on regulation and monopolies.

Pokemon red blue map

What Is the Ratchet Effect? Full text More access options. Stein, Other versions of this item: Anat R. Definition, How It's Used, and Example A mechanic's lien is a legal guarantee of payment to builders, contractors, and subcontractors for the building or renovation of a property. Economic literature: papers , articles , software , chapters , books. If a store whose sales have been stagnant for some time adopts some changes, such as new managerial strategies, staff overhaul, or better incentive programs, and then earns greater revenues than it had previously, the store will find it difficult to justify producing less. The target level of leverage, and the speed of adjustment depends critically on debt maturity; nonetheless, in equilibrium shareholders are indifferent toward the debt maturity structure. Nyborg, You can help correct errors and omissions. As a result, the tax benefits of future debt increases are fully dissipated, and equilibrium equity values match those in a model where the firm commits not to issue new debt. If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. Ikeda, S. Anton Miglo,

Admati, and Peter M. DeMarzo say there is a disincentive for shareholders to urge companies to cut back on borrowing. Drew Kelly.

Create profiles to personalise content. In a dynamic context, since leverage becomes effectively irreversible, firms may limit leverage initially but then ratchet it up in response to shocks. Ilya A. Debt overhang and capital regulation. If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form. This is because the incentives of the bureaucrats who make decisions within government agencies always include their incentive to maintain and improve their positions within the organization and the size and status of the organization itself. Samuel G. Once an auto company has made these investments and added these features, it becomes difficult to scale back production. Strebulaev, Ilya A. We also reference original research from other reputable publishers where appropriate.