Abstract
The presence of publicly traded debt in firm’s capital struct ure leads to coordination and restructuring problems as the firm nears financial distress and investment is distorted. Based on this perspective, we describe the market for debt repurchases as a substitute for renegotiation and examine whether deleveraging improves investment efficiency . We model the choice to repurchase debt and show that investment efficiency improves and the coo rdination problem is mitigated when the firm exchanges cash for outstanding debt. Using a sample o f debt repurchases initiated by U.S. firms from 1996 to 2010, we find find that firms are more likely to r epurchase outstanding debt either by open market transactions or tender offers when investment frictions are relatively high. We document significant increases in firm investment levels a nd efficiency for repurchasing firms relative to a control sample. This improvement is more pronounced for firms with higher expected transfers to bondholders. To address the potential endogeneity of the repurchase choice and investment, we examine an exogenous shock to the incentives to repurchase debt provided by the passing of the American Recovery and Reinvestment Act of 2009 and find similar improvements in investment efficiency.
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