Essays on The Effects of Variable Debt Obligations
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This dissertation consists of three essays on variable debt obligations. In the first essay, I develop a novel dataset to examine the impact of pension group annuity purchases on capital structure and corporate policies. Pension obligations are shown to contribute to rising cash flow volatility to stakeholders, which is a prominent factor in the decision to offload these liabilities. I find the reduction in pension debt is replaced with a commensurate dollar value of long-term debt. The substitution is concentrated in financially unconstrained firms, while those facing greater financial constraints reduce total leverage. Firms engaging in a group annuity purchase increase pension contributions and capital expenditures in the event year. Consistent with a lower expected probability of future cash shortfalls, changes to investment policy are concentrated in financially constrained firms. Short and long horizon event studies reveal pension annuity buyouts are associated with significantly negative abnormal returns due to disappointing cash flow news upon announcement. In the second chapter of the dissertation, we exploit an exogenous, universal increase in discount rates mandated by the Moving Ahead for Progress Act (MAP-21) to identify the impact of pension overhang on investment. We find that firms with large unfunded pension liabilities increase investment by 13% after the MAP-21 induced decrease in pension liabilities. The effects are more pronounced for ex-ante financially constrained firms, yet pension-related cash flows have a minimal impact on investment. Credit ratings of affected firms improve while CEOs with more pay-for-performance and longer horizon increase investment to a greater extent after MAP-21. Our results highlight the role of pension overhang on investment. In the third chapter, we examine the relative pricing of nominal Treasury bonds and Treasury inflation-protected securities (TIPS) in the presence of United States default risk. Higher bond yields are associated with a higher U.S. credit default swap premium, but more so for TIPS. This leads to a narrower breakeven inflation (BEI). An estimated no-arbitrage model shows BEI is related to differing expectations of loss given default on the two Treasury securities and that most of the relative mispricing after the financial crisis can be attributed to default risk. Our finding suggests credit risk is embedded in the pricing of U.S. sovereign debt.