This paper analyses the incentives of the equityholders of a leveraged company to shut it down in a continuous time, stochastic environment. Keeping the firm as an ongoing concern has an option value but equity and debt holders value it differently. Equityholders decisions exhibit excessive continuation and reduce firms value. Using a compound exchange option approach, we characterise the resulting agency costs of debt, derive the ¶price¶ of these costs and analyse their dynamics. We also show how agency costs can be reduced by the design of debt and the possibility of renegotiation.
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Paper provided by Financial Markets Group in its series FMG Discussion Papers with number
dp348.