Investment Options With Debt Financing Constraints
50 Pages Posted: 20 Mar 2007 Last revised: 9 Mar 2008
Date Written: February 2008
We use a contingent claims model to study the impact of debt financing constraints on firm value, optimal capital structure, the timing of investment and other variables like the credit spreads. The optimal investment trigger follows a U-shape as a function of the constraint. Equity financed risky growth options (e.g. R&D or experimentation) reduce the impact of debt constraints and increase firm value by increasing the option value on unlevered assets. Growth options have a small impact on the expected net benefits of debt. We also investigate the effect of debt financing constraints on government taxes and social welfare.
Keywords: Capital Structure, Financing Constraints, Endogenous Default, Real Options, Growth Options
JEL Classification: G31, G13
Suggested Citation: Suggested Citation