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Investment timing and capital structure with loan guarantees

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  • Xiang, Hua
  • Yang, Zhaojun

Abstract

The equity-for-guarantee swap (EGS) is a new popular financial derivative. We derive closed-form solutions for the interaction of the optimal investment and financing with the swap in a real-options framework. We find that there is an U-shaped relationship between investment timing and the coupon payment. In contrast to the classical model, EGS induces different investment and financing strategies. In particular, it delays investment. Whether the swap leads to debt overhang distortion depends on guarantee cost and the profitability of the project but it induces the borrower’s risk-shifting incentive. The larger the guarantee cost, the stronger the incentive.

Suggested Citation

  • Xiang, Hua & Yang, Zhaojun, 2015. "Investment timing and capital structure with loan guarantees," Finance Research Letters, Elsevier, vol. 13(C), pages 179-187.
    • Handle: RePEc:eee:finlet:v:13:y:2015:i:c:p:179-187
    DOI: 10.1016/j.frl.2015.01.006
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    Cited by:

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    More about this item

    Keywords

    Loan guarantees; Real options; Capital structure;
    All these keywords.

    JEL classification:

    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • G11 - Financial Economics - - General Financial Markets - - - Portfolio Choice; Investment Decisions
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G24 - Financial Economics - - Financial Institutions and Services - - - Investment Banking; Venture Capital; Brokerage

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