Get access

The Effects of Risky Debt on Investment Under Uncertainty

Authors


  • The author thanks two anonymous referees, Lorenzo Garlappi, Chang-Soo Kim (Editor), Jaehyon Lee (AKFAs discussant) and participants at the 2011 AKFAs Conference for helpful discussions and suggestions. A travel support from the KAFA is gratefully acknowledged. All errors are mine.

Corresponding author: Seung Dong You, Department of Economics and Finance, Sangmyung University, 7 Hongji-Dong Jongno-Gu, Seoul (110–743). Tel: +82-2-2287-5258, Fax: +82-2-2287-0059, email: peteryou@smu.ac.kr.

Abstract

This paper investigates investment and disinvestment decisions when an investor finances debt to fund the lump-sum cost at the time of investment. The study examines investment timing decisions in a frictionless financial market. By extending the model presented in Dixit (1989), this paper argues that, as risky debt increases, an investor's trigger price for investment decreases while the trigger price for disinvestment increases. Such an investor hastens both investment and disinvestment decisions with risky debt. This paper focuses on stand-alone financing rather than expansion financing, as in Lyandres and Zhdanov (2010).

Ancillary