A game options approach to the investment problem with convertible debt financing
We consider a firm that operates a single plant and has an expansion option to invest in a new plant with convertible debt financing. This conversion feature introduces another complication not only because of the added conversion timing problem (by the bond holder) but also because the equity holder needs to take future conversion into account when evaluating her expansion/financing decision. We have two main objectives here. We use game options techniques to analyze optimal strategies involved in this convertible debt financed expansion problem. The first goal is to provide a comprehensive framework and procedure for solving the problem in a mathematically tractable way. Secondly, we illustrate our solution method through a concrete example with economic analysis. This includes a comparison with straight bond financing and comparative statics with respect to price volatility and conversion ratio. In this regard, we attempt to clarify how the conversion feature affects the equity holder's investment decisions. Throughout the paper, we study expansion options by viewing a firm's existing operation, bankruptcy threat, conversion decisions and financing decisions all together.
If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.
As the access to this document is restricted, you may want to look for a different version under "Related research" (further below) or search for a different version of it.
References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
- Gong, Pu & He, Zhiwei & Zhu, Song-Ping, 2006. "Pricing convertible bonds based on a multi-stage compound-option model," Physica A: Statistical Mechanics and its Applications, Elsevier, vol. 366(C), pages 449-462.
- 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.
- Dayanik, Savas & Karatzas, Ioannis, 2003. "On the optimal stopping problem for one-dimensional diffusions," Stochastic Processes and their Applications, Elsevier, vol. 107(2), pages 173-212, October.
- Kyoko Yagi & Ryuta Takashima & Hiroshi Takamori & Katsushige Sawaki, 2008. "Timing of Convertible Debt Financing and Investment," CARF F-Series CARF-F-131, Center for Advanced Research in Finance, Faculty of Economics, The University of Tokyo.
- Childs, Paul D. & Mauer, David C. & Ott, Steven H., 2005. "Interactions of corporate financing and investment decisions: The effects of agency conflicts," Journal of Financial Economics, Elsevier, vol. 76(3), pages 667-690, June.
- Christopher A. Hennessy, 2004. "Tobin's "Q", Debt Overhang, and Investment," Journal of Finance, American Finance Association, vol. 59(4), pages 1717-1742, 08.
- Hennessy, Christopher A. & Tserlukevich, Yuri, 2008. "Taxation, agency conflicts, and the choice between callable and convertible debt," Journal of Economic Theory, Elsevier, vol. 143(1), pages 374-404, November.
- Mauer, David C. & Sarkar, Sudipto, 2005. "Real options, agency conflicts, and optimal capital structure," Journal of Banking & Finance, Elsevier, vol. 29(6), pages 1405-1428, June.
- Egami, Masahiko, 2009. "A framework for the study of expansion options, loan commitments and agency costs," Journal of Corporate Finance, Elsevier, vol. 15(3), pages 345-357, June.
- Sarkar, Sudipto, 2003. "Early and late calls of convertible bonds: Theory and evidence," Journal of Banking & Finance, Elsevier, vol. 27(7), pages 1349-1374, July.
- Yuri Kifer, 2000. "Game options," Finance and Stochastics, Springer, vol. 4(4), pages 443-463.
- Korkeamaki, Timo & Moore, William T., 2004. "Capital investment timing and convertible debt financing," International Review of Economics & Finance, Elsevier, vol. 13(1), pages 75-85.
When requesting a correction, please mention this item's handle: RePEc:eee:dyncon:v:34:y:2010:i:8:p:1456-1470. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Zhang, Lei)
If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.
If references are entirely missing, you can add them using this form.
If the full references list an item that is present in RePEc, but the system did not link to it, you can help with this form.
If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your profile, as there may be some citations waiting for confirmation.
Please note that corrections may take a couple of weeks to filter through the various RePEc services.