Growth Option Exercise and Capital Structure
AFA 2013 San Diego Meetings Paper
47 Pages Posted: 17 Nov 2011 Last revised: 1 Jan 2015
Date Written: Decrmber 31, 2014
We document that firms decrease their leverage when they convert growth options into tangible assets. We argue that the act of growth option exercise decreases information asymmetry about the firm, which in turn reduces the relative cost of issuing information-sensitive securities such as equity. We show that leverage is negatively correlated with unexpected capital expenditure, our proxy for growth option conversion. The negative relationship becomes stronger when the information environment of a firm deteriorates following a reduction in analyst coverage after a brokerage house merger. Overall, our findings are contrary to standard trade-off and pecking order theories, but are consistent with recent work on signaling and growth options.
Keywords: Growth Option, Capital Structure
JEL Classification: G32
Suggested Citation: Suggested Citation