On the debt Capacityof growth Options

Michael J. Barclay (), Erwan Morellec () and Clifford W. Smith ()
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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

FAME Research Paper Series from International Center for Financial Asset Management and Engineering

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.

Keywords: Growth options; Book leverage (search for similar items in EconPapers)
JEL-codes: G31 G32 (search for similar items in EconPapers)
Date: 2003-01
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Citations: View citations in EconPapers (1)

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