A NOTE ON CORPORATE INVESTMENT DECISIONS AND OPTION PRICING

Using the Black-Scholes option pricing model, numerical examples are given which illustrate the known fact that shareholders in a levered firm might reject investments which are profitable for the company as a whole and accept investments which are unprofitable for the company as a whole. Even the assumption that side-payments are allowed can be inadequate to handle a possible succession of unprofitable projects which are acceptable to shareholders. However, existing company law attempts to provide a solution procedure. The analysis helps to explain why such law has been thought necessary.