On the Debt Capacity of Growth Options

On the Debt Capacity of Growth Options

If debt capacity is defined as the incremental debt optimally associated with an additional asset, then the debt capacity of growth options is negative. The underinvestment costs of debt increase and free cash flow benefits of debt fall with additional growth options. Thus, if firm value increases w...

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Bibliographic Details
Published in:The Journal of business (Chicago, Ill.) Ill.), 2006-01, Vol.79 (1), p.37-60
Main Authors: Barclay, Michael J., Smith, Jr, Clifford W., Morellec, Erwan
Format: Article
Language:eng
Subjects:
Assets
Book value
Business growth
Business studies
Business valuation
Corporate debt
Correlation analysis
Debt
Debt capacity
Debt management
Economic growth
Financial investments
Financial leverage
Financial liabilities
Financial management
Investment
Investment policy
Investment strategies
Investment value
Regression analysis
Studies
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Summary:If debt capacity is defined as the incremental debt optimally associated with an additional asset, then the debt capacity of growth options is negative. The underinvestment costs of debt increase and free cash flow benefits of debt fall with additional growth options. Thus, if firm value increases with additional growth options, then not only does leverage decline but the firm's optimal total debt level declines as well. This result implies a negative relation between book leverage and growth options and provides a new economic interpretation of book leverage regressions.
ISSN:0021-9398
1537-5374