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A Direct Test of Agency Theories of Debt: Evidence from Residential Mortgage-Backed Securities

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  • Yilin Huang

    (Federal Reserve Bank of Philadelphia, Philadelphia, Pennsylvania 19106)

  • Taylor D. Nadauld

    (Department of Finance, Brigham Young University, Provo, Utah 84602)

Abstract

When a firm is facing default, equity holders have incentives to engage in asset substitution, underinvest, or directly transfer wealth. Few papers document investment distortions on account of debt-equity agency conflicts, only that the threat of distortions influence ex ante financing costs. A nonagency residential mortgage-backed security deal represents an entity that is highly leveraged where, ex ante, equity holders know they will face default. This provides an ideal laboratory for testing whether the threat of default creates any of the distortions predicted in theory. We estimate a lower bound on agency costs associated with direct wealth transfers to be in the range of $.018 per dollar.

Suggested Citation

  • Yilin Huang & Taylor D. Nadauld, 2019. "A Direct Test of Agency Theories of Debt: Evidence from Residential Mortgage-Backed Securities," Management Science, INFORMS, vol. 65(4), pages 1792-1809, April.
    • Handle: RePEc:inm:ormnsc:v:65:y:2019:i:4:p:1792-1809
    DOI: 10.1287/mnsc.2017.2853
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    References listed on IDEAS

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