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

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  • Lambrecht, Bart M.
  • Myers, Stewart C.

Abstract

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.

Suggested Citation

  • Lambrecht, Bart M. & Myers, Stewart C., 2008. "Debt and managerial rents in a real-options model of the firm," Journal of Financial Economics, Elsevier, vol. 89(2), pages 209-231, August.
  • Handle: RePEc:eee:jfinec:v:89:y:2008:i:2:p:209-231
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    References listed on IDEAS

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    1. repec:eee:jbfina:v:81:y:2017:i:c:p:221-235 is not listed on IDEAS
    2. Agliardi, Elettra & Andergassen, Rainer, 2009. "Last resort gambles, risky debt and liquidation policy," Review of Financial Economics, Elsevier, vol. 18(3), pages 142-155, August.
    3. Viral V. Acharya & Stewart C. Myers & Raghuram G. Rajan, 2011. "The Internal Governance of Firms," Journal of Finance, American Finance Association, vol. 66(3), pages 689-720, June.
    4. Amaresh K. Tiwari & Pierre Mohnen & Franz Palm & Sybrand Schim van der Loeff, 2012. "Microeconometric Evidence of Financing Frictions and Innovative Activity," CIRANO Working Papers 2012s-24, CIRANO.
    5. Neuhäusler , Peter & Schubert, Torben & Frietsch , Rainer & Blind , Knut, 2015. "Managing Portfolio Risk in Strategic Technology Management: Evidence from a Panel Data Set of the World’s Largest R&D Performers," Papers in Innovation Studies 2015/41, Lund University, CIRCLE - Center for Innovation, Research and Competences in the Learning Economy.
    6. Douglas W. Diamond & Zhiguo He, 2014. "A Theory of Debt Maturity: The Long and Short of Debt Overhang," Journal of Finance, American Finance Association, vol. 69(2), pages 719-762, April.
    7. Wen, Chunhui & Xia, Xin & Yang, Jinqiang, 2017. "Idiosyncratic risk, the private benefits of control and investment timing," Economics Letters, Elsevier, vol. 153(C), pages 65-71.
    8. Hori, Keiichi & Osano, Hiroshi, 2014. "Investment timing decisions of managers under endogenous contracts," Journal of Corporate Finance, Elsevier, vol. 29(C), pages 607-627.
    9. Koussis, Nicos & Martzoukos, Spiros H. & Trigeorgis, Lenos, 2017. "Corporate liquidity and dividend policy under uncertainty," Journal of Banking & Finance, Elsevier, vol. 75(C), pages 200-214.
    10. Brennan, Michael J. & Kraft, Holger, 2015. "Leaning against the wind: Debt financing in the face of adversity," SAFE Working Paper Series 119, Research Center SAFE - Sustainable Architecture for Finance in Europe, Goethe University Frankfurt.
    11. Franklin Allen & Sudipto Bhattacharya & Raghuram Rajan & Antoinette Schoar, 2008. "The Contributions of Stewart Myers to the Theory and Practice of Corporate Finance," Journal of Applied Corporate Finance, Morgan Stanley, vol. 20(4), pages 8-19.
    12. Patrick Bolton & Neng Wang & Jinqiang Yang, 2014. "Investment Under Uncertainty and the Value of Real and Financial Flexibility," NBER Working Papers 20610, National Bureau of Economic Research, Inc.
    13. Michi Nishihara & Takashi Shibata, 2017. "Dynamic bankruptcy procedure with asymmetric information between insiders and outsiders," Discussion Papers in Economics and Business 17-18, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP).
    14. Huang, Hsing-Hua & Huang, Hongming & Shih, Pai-Ta, 2012. "Real options and earnings-based bonus compensation," Journal of Banking & Finance, Elsevier, vol. 36(8), pages 2389-2402.
    15. Edmans, Alex, 2011. "Short-term termination without deterring long-term investment: A theory of debt and buyouts," Journal of Financial Economics, Elsevier, vol. 102(1), pages 81-101, October.

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