Growth Option Exercise and Capital Structure*

Illiquidity and stock returns: cross-section and time series effects

Amiyatosh Purnanandam and Uday Rajan

Review of Finance, 2018, vol. 22, issue 1, 177-206

Abstract: We document that firms decrease their leverage when they convert growth options into tangible assets. We argue that the act of growth option exercise decreases information asymmetry about the firm, which in turn reduces the relative cost of issuing information-sensitive securities such as equity. We show that leverage is negatively correlated with unexpected capital expenditure, our proxy for growth option conversion. The negative relationship becomes stronger when the information environment of a firm deteriorates following a reduction in analyst coverage after a brokerage house merger. Overall, our findings are contrary to standard trade-off and pecking order theories, but are consistent with recent work on signaling and growth options.

Keywords: Growth option; Capital expenditure; Signaling (search for similar items in EconPapers)
Date: 2018
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Citations: View citations in EconPapers (1)

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