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On the Debt Capacity of Growth Options

Author

Listed:
  • Michael J. Barclay

    (University of Rochester)

  • Erwan Morellec

    (University of Lausanne,)

Abstract

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.

Suggested Citation

  • Michael J. Barclay & Erwan Morellec, 2006. "On the Debt Capacity of Growth Options," The Journal of Business, University of Chicago Press, vol. 79(1), pages 37-60, January.
    • Handle: RePEc:ucp:jnlbus:v:79:y:2006:i:1:p:37-60
    DOI: 10.1086/497404
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