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Excessive Continuation and Dynamic Agency Costs of Debt

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  • Décamps, Jean-Paul
  • Faure-Grimaud, Antoine

Abstract

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 firm's value. Using a compounbd 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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Bibliographic Info

Paper provided by Institut d'Économie Industrielle (IDEI), Toulouse in its series IDEI Working Papers with number 99.

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Date of creation: 2000
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Publication status: Published in European Economic Review, vol.�46, Elsevier, 2002, p.�1623-1644.
Handle: RePEc:ide:wpaper:678

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  1. Jean-Charles Rochet & Jean-Paul DÊcamps, 1997. "A variational approach for pricing options and corporate bonds," Economic Theory, Springer, vol. 9(3), pages 557-569.
  2. Oliver Hart & John Moore, 1998. "Default And Renegotiation: A Dynamic Model Of Debt," The Quarterly Journal of Economics, MIT Press, vol. 113(1), pages 1-41, February.
  3. Pierre Mella-Barral & William R M Perraudin, 1993. "Strategic Debt Service," CEPR Financial Markets Paper 0039, European Science Foundation Network in Financial Markets, c/o C.E.P.R, 77 Bastwick Street, London EC1V 3PZ.
  4. Hayne E. Leland and Klaus Bjerre Toft., 1995. "Optimal Capital Structure, Endogenous Bankruptcy, and the Term Structure of Credit Spreads," Research Program in Finance Working Papers RPF-259, University of California at Berkeley.
  5. David De Meza & Ben Lockwood, 1998. "Does Asset Ownership Always Motivate Managers? Outside Options And The Property Rights Theory Of The Firm," The Quarterly Journal of Economics, MIT Press, vol. 113(2), pages 361-386, May.
  6. Carr, Peter P, 1988. " The Valuation of Sequential Exchange Opportunities," Journal of Finance, American Finance Association, vol. 43(5), pages 1235-56, December.
  7. Hayne E. Leland., 1998. "Agency Costs, Risk Management, and Capital Structure," Research Program in Finance Working Papers RPF-278, University of California at Berkeley.
  8. McDonald, Robert L & Siegel, Daniel R, 1985. "Investment and the Valuation of Firms When There Is an Option to Shut Down," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 26(2), pages 331-49, June.
  9. Geske, Robert, 1977. "The Valuation of Corporate Liabilities as Compound Options," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 12(04), pages 541-552, November.
  10. Anderson, Ronald W. & Sundaresan, Suresh & Tychon, Pierre, 1996. "Strategic analysis of contingent claims," European Economic Review, Elsevier, vol. 40(3-5), pages 871-881, April.
  11. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
  12. Hart, Oliver D. & Moore, John, 1990. "Property Rights and the Nature of the Firm," Scholarly Articles 3448675, Harvard University Department of Economics.
  13. Mella-Barral, Pierre, 1999. "The Dynamics of Default and Debt Reorganization," Review of Financial Studies, Society for Financial Studies, vol. 12(3), pages 535-78.
  14. Anderson, Ronald W & Sundaresan, Suresh, 1996. "Design and Valuation of Debt Contracts," Review of Financial Studies, Society for Financial Studies, vol. 9(1), pages 37-68.
  15. Mello, Antonio S & Parsons, John E, 1992. " Measuring the Agency Cost of Debt," Journal of Finance, American Finance Association, vol. 47(5), pages 1887-904, December.
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Cited by:
  1. Jean-Paul Décamps & Bertrand Djembissi, 2007. "Switching to a poor business activity: optimal capital structure, agency costs and covenant rules," Annals of Finance, Springer, vol. 3(3), pages 389-409, July.
  2. 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.
  3. Bart Lambrecht & Stewart C. Myers, 2005. "A Theory of Takeovers and Disinvestment," NBER Working Papers 11082, National Bureau of Economic Research, Inc.
  4. Duffie, Darrell, 2003. "Intertemporal asset pricing theory," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 11, pages 639-742 Elsevier.
  5. Alan Schwartz, . "A Normative Theory of Business Bankruptcy," American Law & Economics Association Annual Meetings 1037, American Law & Economics Association.
  6. Moyen, Nathalie, 2007. "How big is the debt overhang problem?," Journal of Economic Dynamics and Control, Elsevier, vol. 31(2), pages 433-472, February.

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