Dynamic Capital Structure with Callable Debt and Debt Renegotiations

Peter Ove Christensen, Christian Riis Flor, David Lando, Kristian Miltersen

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We consider a dynamic trade-off model of a firm’s capital structure with debt renegotiation. Debt holders only accept restructuring offers from equity holders backed by threats which are in the equity holders’ own interest to execute. Our model shows that in a complete information model in which taxes and bankruptcy costs are the only frictions, violations of the absolute priority rule (APR) are typically optimal. The size of the bankruptcy costs and the equity holders’ bargaining power affect the size of APR violations, but they have only a minor impact on the choice of capital structure.
Original languageEnglish
JournalJournal of Corporate Finance
Pages (from-to)644-661
Number of pages18
Publication statusPublished - Dec 2014


  • Dynamic capital structure
  • Debt restructuring
  • Violation of absolute priority

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