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Can real options explain financing behavior?

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  • Tserlukevich, Yuri
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    Abstract

    Trade-off models commonly invoke financial transaction costs in order to explain observed leverage fluctuations. This paper offers an alternative explanation based on real options. The model is frictionless on the financing side but incorporates irreversibility and fixed costs of investment. Results obtained from simulating the model are broadly consistent with observed financing patterns. Market leverage ratios are negatively related to profitability, mean-reverting, and depend on past stock returns. The gradual and lumpy leverage adjustments can occur in the absence of financial transaction costs. This evidence shows that incorporating real frictions into structural models increases their explanatory power.

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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: 232-252

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    Handle: RePEc:eee:jfinec:v:89:y:2008:i:2:p:232-252

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

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    Cited by:
    1. DeAngelo, Harry & DeAngelo, Linda & Whited, Toni M., 2011. "Capital structure dynamics and transitory debt," Journal of Financial Economics, Elsevier, vol. 99(2), pages 235-261, February.
    2. Kit Wong, 2010. "On the neutrality of debt in investment intensity," Annals of Finance, Springer, vol. 6(3), pages 335-356, July.

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