We derive the optimal dynamic contract in a continuous-time principal-agent setting, and implement it with a capital structure (credit line, long-term debt, and equity) over which the agent controls the payout policy. While the project's volatility and liquidation cost have little impact on the...

Financial distress is more likely to happen in bad times. The present value of distress costs therefore depends on risk premia. We estimate this value using risk-adjusted default probabilities derived from corporate bond spreads. For a BBB-rated firm, our benchmark calculations show that the NPV...