Accelerated investment effect of risky debt

Evgeny Lyandres, Alexei Zhdanov

Research output: Contribution to journalArticlepeer-review

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
Pages (from-to)2587-2599
Number of pages13
JournalJournal of Banking and Finance
Volume34
Issue number11
DOIs
StatePublished - Nov 2010
Externally publishedYes

Keywords

  • Accelerated investment
  • Leverage
  • Real options
  • Underinvestment

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