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

  • Lambrecht, Bart M.
  • Myers, Stewart C.
Registered author(s):

    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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    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
    Contact details of provider: Web page: http://www.elsevier.com/locate/inca/505576

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