Interaction between Dynamic Financing and Investments: The Role of Priority Rules

40 Pages Posted: 10 Mar 2016

See all articles by Engelbert J. Dockner

Engelbert J. Dockner

WU Vienna University of Economics and Business (deceased)

Joril Maeland

NHH Norwegian School of Economics - Department of Finance

Kristian R. Miltersen

Copenhagen Business School

Date Written: March 8, 2016

Abstract

We analyze in a dynamic model how debt priority rules influence firms' initial capital structure choice, investment timing, and subsequent debt issues. We quantify deviations from first-best investment behavior that arise from different debt priority rules, and document surprisingly large deviations caused by well-known rules such as the absolute priority rule. We introduce a new rule, called the efficient priority rule (EPR), that gives equity holders incentives to choose first-best investment timing and financing. Under EPR, old debt has the same value and risk characteristics as if the firm had not invested and new debt had not been issued.

Keywords: Dynamic capital structure, taxes and optimal debt structure, structural model, credit risk, priority rule, investment and financing decisions

JEL Classification: G32

Suggested Citation

Dockner, Engelbert J. and Maeland, Joril and Miltersen, Kristian Risgaard, Interaction between Dynamic Financing and Investments: The Role of Priority Rules (March 8, 2016). Available at SSRN: https://ssrn.com/abstract=2744834 or http://dx.doi.org/10.2139/ssrn.2744834

Engelbert J. Dockner

WU Vienna University of Economics and Business (deceased)

Heiligenstaedter Strasse 46-48
Vienna, 1190
Austria
+431313366302 (Phone)
+43131336906302 (Fax)

HOME PAGE: http://www.wu.ac.at/finance/people/faculty/list/dockner

Joril Maeland (Contact Author)

NHH Norwegian School of Economics - Department of Finance ( email )

Helleveien 30
N-5045 Bergen
Norway

Kristian Risgaard Miltersen

Copenhagen Business School ( email )

Solbjerg Plads 3
Frederiksberg C, DK - 2000
Denmark

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