Abstract: This paper presents a strategic model of temporarily high leverage. When the repayment of senior claims depends in part upon further investment, shareholders may be able to alter credibly their incentives to invest through an exchange of junior debt for equity and thereby force concessions from senior creditors. The authors focus on the conflict between shareholders and risk-averse workers and show that this strategic use of debt leads to an inefficient allocation of risk. They characterize conditions under which firms will undergo leveraged recapitalizations, their choice of debt instruments, and the dynamics of their capital structure.