Debt overhang, costly expandability and reversibility, and optimal financial structure
Resource
Journal of Business Finance and Accounting 31:7&8, 1191-1222
Journal
Journal of Business Finance and Accounting 31:7&8
Journal Volume
31
Journal Issue
7-8
Pages
1191-1222
Date Issued
2004-10
Date
2004-10
Author(s)
Tan Lee
Abstract
Abstract: This article compares the investment and financing decisions of a firm that adopts a ‘first‐best’ strategy with those of a firm that adopts a ‘second‐best’ strategy. The former issues bonds upon deciding an initial capacity, while the latter issues bonds, and only then decides an initial capacity. The former is thus able to avoid the agency cost associated with the ‘debt overhang’ problem. Accordingly, the former will both issue more bonds and install a larger initial capacity than the latter. However, the agency cost of debt, i.e., firm value difference between these two strategies, is modest for plausible parameter values.
Subjects
bankruptcy costs, debt overhang, expandability, financial structure, reversibility
SDGs
Type
journal article
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