Underinvestment,capital structure and strategic debt restructuring |
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Authors: | Grzegorz Pawlina |
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Institution: | 1. DSB 302, McMaster University, Hamilton, ON L8S 4M4, Canada;2. DSB A210, McMaster University, Hamilton, ON L8S 4M4, Canada;1. Graduate School of Social Sciences, Tokyo Metropolitan University, 1-1 Minami-osawa, Hachioji, Tokyo 192-0397, Japan;2. Graduate School of Economics, Osaka University, 1-7 Machikaneyama, Toyonaka, Osaka 560-0043, Japan;3. Swiss Finance Institute, École Polytechnique Fédérale de Lausanne, 1015 Lausanne, Switzerland |
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Abstract: | This paper shows that shareholders' option to renegotiate debt in a period of financial distress exacerbates Myers' (1977) underinvestment problem at the time of the firm's expansion. This result is a consequence of a higher wealth transfer from shareholders to creditors occurring upon investment in the presence of the option to renegotiate. This additional underinvestment is eliminated by granting creditors the entire bargaining power. In such a case, renegotiation commences at shareholders' bankruptcy trigger so no additional wealth transfer occurs. In addition to deriving the firm's policies, we provide results on the values of corporate claims, the agency cost of debt, and the optimal capital structure. Empirically, we predict, among others, a lower sensitivity of capital investment to shocks to Tobin's q and cash flow for firms financed with renegotiable debt, and a negative effect of debt renegotiability on the relationship between growth opportunities and systematic risk as well as leverage. |
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