Abstract
The presence of debt in a firm's capital structure may induce equity claimants to choose an investment policy that is not in the best interest of all claimants. Since Myers (1977) and Jensen and Meckling (1976), the debt overhang and asset substitution investment distortions are well recognized. However, the previous literature did not reach a consensus as to the magnitude of such costs. This paper re-examines the debt overhang problem, but in a framework where the firm is allowed to recapitalize at any point in time and where the investment level rather than the binary operating policy is used to measure the size of the underinvestment caused by debt financing. The debt overhang problem is shown to do little harm to equity claimants. In bad economic conditions when the marginal productivity of capital is low, equity claimants actually benefit from the underinvestment. They only suffer in better economic conditions.
Talk to us
Join us for a 30 min session where you can share your feedback and ask us any queries you have
Schedule a callDisclaimer: All third-party content on this website/platform is and will remain the property of their respective owners and is provided on "as is" basis without any warranties, express or implied. Use of third-party content does not indicate any affiliation, sponsorship with or endorsement by them. Any references to third-party content is to identify the corresponding services and shall be considered fair use under The CopyrightLaw.
