Reducing agency conflicts with target debt ratios

Unyong Pyo (), Yong Shin () and Howard Thompson ()

Journal of Economics and Finance, 2015, vol. 39, issue 3, 453 pages

Abstract: We show how target debt ratios in book value terms applied to new investment can improve alignment of investment incentives in firms when they have risky debt outstanding and asymmetric information. While wealth transfer from both agency conflicts can reduce the value of existing equity, new debt offsets the value loss to old shareholders. New debt set by the target debt ratio naturally reflects key factors such as the NPV and size of the new project and offsets wealth transfers. Numerical examples show that both agency conflicts can be eliminated both in structural models and in binomial models. Copyright Springer Science+Business Media New York 2015

Keywords: Target debt ratios; Investment incentives; Underinvestment; Asymmetric information; G11; G32 (search for similar items in EconPapers)
Date: 2015
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DOI: 10.1007/s12197-013-9256-0

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