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On the debt Capacityof growth Options

Author

Listed:
  • Michael J. Barclay

    (Simon School of Business, University of Rochester)

  • Erwan Morellec

    (HEC, University of Lausanne and FAME)

  • Clifford W. Smith

    (Simon School of Business, University of Rochester)

Abstract

If debt capacity is defined as the incremental debt that is optimally associated with an additional asset, then the debt capacity of growth options is negative. 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 leverage not only declines, 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 & Clifford W. Smith, 2003. "On the debt Capacityof growth Options," FAME Research Paper Series rp121, International Center for Financial Asset Management and Engineering.
    • Handle: RePEc:fam:rpseri:rp121
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    File URL: http://www.swissfinanceinstitute.ch/rp121.pdf
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    References listed on IDEAS

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    Cited by:

    1. Norman Schuerhoff, 2004. "Capital Gains Taxes, Irreversible Investment, and Capital Structure," 2004 Meeting Papers 688, Society for Economic Dynamics.

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    More about this item

    Keywords

    Growth options; Book leverage;

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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