Abstract
This article constructs a real options model in which a firm has a privileged right to exercise an irreversible investment project with a stochastic payoff. Supposing that the investment costs are fully sunk, a firm that exercises the investment option after debt is in place will then choose a better state to exercise this option as it issues more bonds. This debt-overhang phenomenon, however, benefits the firm since waiting is itself valuable. Accordingly, the firm will both exercise the investment option later and issue more bonds as compared with a firm that issues bonds upon exercising the investment option.
Original language | English |
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Pages (from-to) | 489-509 |
Number of pages | 21 |
Journal | European Journal of Finance |
Volume | 10 |
Issue number | 6 |
DOIs | |
State | Published - Dec 2004 |
Keywords
- Bankruptcy
- Financial structure
- Irreversible investment
- Limited liability