Leland, Hayne E., "Corporate Debt Value, Bond Covenants, and Optimal Capital Structure", Journal of Finance, Vol. 49, No. 4, (September 1994), pp. 1213-1252.
Abstract: This article examines corporate debt values and capital structure in a unified analytical framework. It derives closed-form results for the value of long-term risky debt and yield spreads, and for optimal capital structure, when firm asset value follows a diffusion process with constant volatility. Debt values and optimal leverage are explicitly linked to firm risk, taxes, bankruptcy costs, risk-free interest rates, payout rates, and bond covenants. The results elucidate the different behavior of junk bonds versus investment-grade bonds, and aspects of asset substitution, debt repurchase, and debt renegotiation.