Fixed Life Projects: Agency Conflicts and Optimal Leverage

63 Pages Posted: 15 Feb 2008

See all articles by Ricardo V.A.P. Correia

Ricardo V.A.P. Correia

University of Manchester - Division of Accounting and Finance; Universidad Carlos III de Madrid

Sydney Howell

University of Manchester - Manchester Business School

Peter Duck

University of Manchester - Department of Mathematics

Date Written: January 12, 2008

Abstract

This paper analyses a model of the conflicts between equityholders and debtholders, regarding the optimal exercise moment for a firm to invest in a concession contract. This setting reflects the reality of, not only traditional concessions, but also image rights and audiovisual rights contracts.

The results support the coexistence of two different incentives (overinvestment and underinvestment) in one single type of real flexibility (option to invest). Overinvestment incentives are shown to clearly dominate underinvestment incentives, in terms of their impact in the value of the firm, and they influence the investment behaviour of equityholders at expiry of the investment option. Varying predictions are presented regarding agency costs and optimal debt levels, under different market conditions and for different asset characteristics, and this fact reiterates the impact of agency conflicts in lowering optimal debt levels. The results also show how in different cases different debt repayment schedules can optimize the value of the firm operating the concession, even if in some of these cases the optimal debt repayment schedule is the one more sensitive to agency costs.

Keywords: Real Options, Corporate Financing Decisions, Agency Theory, Concession Contracts

JEL Classification: G32

Suggested Citation

Correia, Ricardo V.A.P. and Howell, Sydney and Duck, Peter, Fixed Life Projects: Agency Conflicts and Optimal Leverage (January 12, 2008). Available at SSRN: https://ssrn.com/abstract=1092481 or http://dx.doi.org/10.2139/ssrn.1092481

Ricardo V.A.P. Correia (Contact Author)

University of Manchester - Division of Accounting and Finance ( email )

Crawford House
Oxford Road
Manchester M13 9PL
United Kingdom

Universidad Carlos III de Madrid ( email )

CL. de Madrid 126
Madrid, Madrid 28903
Spain

Sydney Howell

University of Manchester - Manchester Business School ( email )

Booth Street West
Manchester, M15 6PB
United Kingdom

Peter Duck

University of Manchester - Department of Mathematics ( email )

Oxford Road
Manchester M60 1QD, N/A M13 9PL
United Kingdom

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