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Excessive Continuation and Dynamic Agency Costs of Debt

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  • Décamps, Jean-Paul
  • Faure-Grimaud, Antoine

Abstract

This paper analyses the incentives of the equityholders of a leveraged company to shut it down in a continuous time, stochastic environment. Keeping the firm as an ongoing concern has an option value but equity and debt holders value it differently. Equityholders decisions exhibit excessive continuation and reduce firms value. Using a compound exchange option approach, we characterise the resulting agency costs of debt, derive the ¶price¶ of these costs and analyse their dynamics. We also show how agency costs can be reduced by the design of debt and the possibility of renegotiation.
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  • Décamps, Jean-Paul & Faure-Grimaud, Antoine, 2000. "Excessive Continuation and Dynamic Agency Costs of Debt," IDEI Working Papers 99, Institut d'Économie Industrielle (IDEI), Toulouse.
    • Handle: RePEc:ide:wpaper:678
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    Cited by:

    1. Hui Chen & Gustavo Manso, 2017. "Macroeconomic Risk and Debt Overhang," The Review of Corporate Finance Studies, Society for Financial Studies, vol. 6(1), pages 1-38.
    2. Jean-Paul Décamps & Bertrand Djembissi, 2007. "Switching to a poor business activity: optimal capital structure, agency costs and covenant rules," Annals of Finance, Springer, vol. 3(3), pages 389-409, July.
    3. Agliardi, Elettra & Andergassen, Rainer, 2009. "Last resort gambles, risky debt and liquidation policy," Review of Financial Economics, Elsevier, vol. 18(3), pages 142-155, August.
    4. Bart Lambrecht & Stewart C. Myers, 2005. "A Theory of Takeovers and Disinvestment," NBER Working Papers 11082, National Bureau of Economic Research, Inc.
    5. Moyen, Nathalie, 2007. "How big is the debt overhang problem?," Journal of Economic Dynamics and Control, Elsevier, vol. 31(2), pages 433-472, February.
    6. repec:rim:rimwps:31-07 is not listed on IDEAS
    7. Priyo, Asad Karim Khan & Rahaman, Mohammad M. & Aivazian, Varouj A., 2017. "Overinvesting via delayed exit: An empirical investigation of the cost of excessive continuation," MPRA Paper 118087, University Library of Munich, Germany.
    8. Alan Schwartz, "undated". "A Normative Theory of Business Bankruptcy," American Law & Economics Association Annual Meetings 1037, American Law & Economics Association.
    9. Duffie, Darrell, 2003. "Intertemporal asset pricing theory," Handbook of the Economics of Finance, in: G.M. Constantinides & M. Harris & R. M. Stulz (ed.), Handbook of the Economics of Finance, edition 1, volume 1, chapter 11, pages 639-742, Elsevier.

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    More about this item

    JEL classification:

    • G30 - Financial Economics - - Corporate Finance and Governance - - - General
    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • L10 - Industrial Organization - - Market Structure, Firm Strategy, and Market Performance - - - General

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