Accelerated investment effect of risky debt

Evgeny Lyandres, Alexey Zhdanov

Research output: Contribution to journalArticle

16 Citations (Scopus)

Abstract

In this paper we examine a new effect of risky debt on a firm's investment strategy. We call this effect " accelerated investment" It stems from a potential loss of investment option in the event of default. The possibility of default reduces the value of the option to wait and provides equity holders with an incentive to speed up investment. As a result, in the absence of wealth expropriation by a levered firm's debt holders, its shareholders exercise their investment option earlier than the shareholders of an otherwise identical all-equity firm. This result is at odds with the generally accepted intuition that in the absence of potential wealth transfers and taxes the shareholders of a levered firm would follow the same investment policy as that of an unlevered firm. In addition to providing various illustrations of the accelerated investment effect, we relate its magnitude to the presence of competition for investment opportunities.

Original languageEnglish (US)
Pages (from-to)2587-2599
Number of pages13
JournalJournal of Banking and Finance
Volume34
Issue number11
DOIs
StatePublished - Nov 1 2010

Fingerprint

Debt
Shareholders
Equity
Tax
Investment policy
Investment opportunities
Incentives
Investment strategy
Wealth transfer
Firm investment
Exercise
Wealth
Expropriation
Intuition

All Science Journal Classification (ASJC) codes

  • Finance
  • Economics and Econometrics

Cite this

Lyandres, Evgeny ; Zhdanov, Alexey. / Accelerated investment effect of risky debt. In: Journal of Banking and Finance. 2010 ; Vol. 34, No. 11. pp. 2587-2599.
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Accelerated investment effect of risky debt. / Lyandres, Evgeny; Zhdanov, Alexey.

In: Journal of Banking and Finance, Vol. 34, No. 11, 01.11.2010, p. 2587-2599.

Research output: Contribution to journalArticle

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