Risk incentive problems and foreign currency bonds

Abstract

This paper examines the incentives of stockholders to expropriate bondholder wealth by changing the probability distribution of the firm's assets in a corporation with foreign currency denominated debt outstanding. It is shown that foreign currency bonds attenuate the incentives of stockholders to engage in this wealth expropriation by increasing the volatility of corporate assets. However, foreign currency bonds provide the stockholders with new scope for engaging in this wealth expropriation by altering the correlation between the exchange rate on the foreign currency and the value of corporate assets.