Counterparty Risk and Capital Structure Brent W. Ambrose, Thomas Emmerling, Henry H. Huang and Yildiray Yildirim ∗ Current version: August 27, 2013 Abstract The 2007-2009 financial crisis and recession highlighted the role of counterparty risk in financial contracts, many once thought immune to such problems. However, counterparty risk can be significant in a wide variety of contracting situations and can impact capital structure decisions. Using commercial real estate leases as an example, this paper presents a new model that endogenizes the capital structure of both parties to a contract. We follow Grenadier (1996) and Leland and Toft (1996) to examine the interaction between firm capital structures and equilibrium contract pricing. Moreover, in a commercial lease setting, our model demonstrates that consideration of credit risk is instrumental to confirm the complementarity between lease and debt as suggested by Lewis and Schallheim (1992). Key words : leasing valuation, credit risk, endogenous default JEL Classification: * Ambrose, bwa10@psu.edu, Institute for Real Estate Studies, The Pennsylvania State University, University Park, PA 16802-3306; Emmerling, tjemmerl@syr.edu, Whitman School of Management, Syra- cuse University, 721 University Ave Suite 120, Syracuse, NY 13244; Huang, hongming@ncu.edu.tw, De- partment of Finance, National Central University, No.300, Jung-da Rd., Jung-Li, Taiwan 320, R.O.C.; Yildirim, yildiray@syr.edu, Whitman School of Management, Syracuse University, 721 University Ave Suite 500, Syracuse, NY 13244. We thank Sumit Agarwal for his helpful comments and suggestions.