Thank Anat Admati, Malcolm Baker, Peter DeMarzo, Darrell Duffie, John Roberts, Ilya Strebulaev, a co-editor, and three anonymous referees for helpful comments.
Investment Reversibility and Agency Cost of Debt
Article first published online: 18 MAR 2008
Copyright © 2008 by The Econometric Society
Volume 76, Issue 2, pages 437–442, March 2008
How to Cite
Manso, G. (2008), Investment Reversibility and Agency Cost of Debt. Econometrica, 76: 437–442. doi: 10.1111/j.1468-0262.2008.00838.x
- Issue published online: 18 MAR 2008
- Article first published online: 18 MAR 2008
- Manuscript received June, 2007; final revision received October, 2007.
- Agency problems;
- real options;
- debt financing;
- asset substitution;
- debt overhang;
Previous research has argued that debt financing affects equity-holders' investment decisions, producing substantial inefficiency. This paper shows that the size of this inefficiency depends on the degree of investment reversibility. In a dynamic model of financing and investment, the paper provides an upper bound for the inefficiency produced by debt financing. The upper bound is decreasing in the degree of investment reversibility and is zero when investment is perfectly reversible.