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Debt and managerial rents in a real-options model of the firm

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  • Lambrecht, Bart M.
  • Myers, Stewart C.
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    Abstract

    We present a theory of capital investment and debt and equity financing in a real-options model of a public corporation. The theory assumes that managers maximize the present value of their future compensation (managerial rents), subject to constraints imposed by outside shareholders' property rights to the firm's assets. Absent bankruptcy costs, managers follow an optimal debt policy that generates efficient investment and disinvestment. We show how bankruptcy costs can distort both investment and disinvestment. We also show how managers' personal wealth constraints can lead to delayed investment and increased reliance on debt financing. Changes in cash flow can cause changes in investment by tightening or loosening the wealth constraints. Firms with weaker investor protection adopt higher debt levels.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 89 (2008)
    Issue (Month): 2 (August)
    Pages: 209-231

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    Handle: RePEc:eee:jfinec:v:89:y:2008:i:2:p:209-231

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    Web page: http://www.elsevier.com/locate/inca/505576

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    References

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    Cited by:
    1. Elettra Agliardi & Rainer Andergassen, 2007. "Last Resort Gambles, Risky Debt and Liquidation Policy," Working Paper Series 31-07, The Rimini Centre for Economic Analysis, revised Jul 2007.
    2. Amaresh K. Tiwari & Pierre Mohnen & Franz Palm & Sybrand Schim van der Loeff, 2012. "Microeconometric Evidence of Financing Frictions and Innovative Activity," CIRANO Working Papers 2012s-24, CIRANO.
    3. Huang, Hsing-Hua & Huang, Hongming & Shih, Pai-Ta, 2012. "Real options and earnings-based bonus compensation," Journal of Banking & Finance, Elsevier, vol. 36(8), pages 2389-2402.
    4. Edmans, Alex, 2011. "Short-term termination without deterring long-term investment: A theory of debt and buyouts," Journal of Financial Economics, Elsevier, vol. 102(1), pages 81-101, October.
    5. Douglas W. Diamond & Zhiguo He, 2012. "A Theory of Debt Maturity: The Long and Short of Debt Overhang," NBER Working Papers 18160, National Bureau of Economic Research, Inc.

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