Optimal dividend and investment policy with debt covenants

A firm holds a certain amount of debt to which is associated a financial-ratio covenant between the creditors and the firm. It may be audited at any time and must furnish financial statements to prove that its debt to total... [ view full abstract ]

A firm holds a certain amount of debt to which is associated a financial-ratio covenant between the creditors and the firm. It may be audited at any time and must furnish financial statements to prove that its debt to total assets ratio is less than one. If not, the firm is given a grace period during which it can inject more capital to correct the situation. When its ratio is appropriate, it can also pay out dividends. We consider an optimal control problem in which the value of the assets is controlled by the capital injections and dividends payouts.