Temporal Resolution of Uncertainty, the Investment Policy of Levered Firms and Corporate Debt Yields

Stern School of Business, Department of Finance Working Paper No. Fin-99-044

48 Pages Posted: 11 Mar 2002

See all articles by Alexander Reisz

Alexander Reisz

Office of the Comptroller of the Currency

Kose John

New York University (NYU) - Department of Finance

Multiple version iconThere are 3 versions of this paper

Date Written: March 1, 2002

Abstract

This paper attempts to link the agency literature (concerned with the fact that tensions between bondholders and shareholders may trigger suboptimal investment decisions) with the one dealing with temporal resolution of uncertainty (TRU). We consider here how the speed of resolution of the uncertainty characterizing the firm's operations affects the risk-shifting behavior of a shareholder-aligned manager. It is assumed that investors are risk neutral and that the return on the risky technology is normally distributed. It is shown that the speed of TRU affects monotonically the extent of risk shifting as well as bond yields, even after optimal contracts mitigating deviations from the first-best investment policy have been written. In particular, the optimal investment-restricting covenant is endogenously characterized. Empirical implications are derived and discussed.

Keywords: Agency costs, temporal resolution of uncertainty, corporate debt yields, optimal contracts

JEL Classification: G13, G31, L14

Suggested Citation

Reisz, Alexander and John, Kose, Temporal Resolution of Uncertainty, the Investment Policy of Levered Firms and Corporate Debt Yields (March 1, 2002). Stern School of Business, Department of Finance Working Paper No. Fin-99-044 . Available at SSRN: https://ssrn.com/abstract=303339 or http://dx.doi.org/10.2139/ssrn.303339

Alexander Reisz (Contact Author)

Office of the Comptroller of the Currency ( email )

400 7th Street SW
Washington, DC 20219
United States
(202) 874 6167 (Phone)
(202) 874 5394 (Fax)

Kose John

New York University (NYU) - Department of Finance ( email )

Stern School of Business
44 West 4th Street
New York, NY 10012-1126
United States
212-998-0337 (Phone)
212-995-4233 (Fax)

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