| My dissertation consists of three essays in the field of corporate finance and agency theorem. The first chapter, Investment Distortion from Debt Financing, studies the interaction between corporate financing decisions and investment decisions in a dynamic framework. When the production decision involves an expansion option, the firm trades off tax benefits of debt against two costs of debt financing, namely investment distortion related to exercise of the expansion option and the loss of a valuable expansion opportunity if the firm defaults. The optimal capital structure is all equity for firms with more value in growth options (or intangible assets) and tends to involve debt financing for firms with more value in tangible assets. The second chapter, Investment Distortion and Security Design, shows that security design features may mitigate investment distortion resulting from wealth transfers to debt holders upon exercise of the growth option. In contrast to previous literature where production decisions are fixed, strategic debt service eliminates bankruptcy costs but leads to suboptimal exercise of the growth option in this paper. It may reduce the value of the firm. However, callable debt can mitigate both bankruptcy costs and suboptimal exercise costs.; The third chapter, Investment Distortion from Information Asymmetry , develops a dynamic framework to study financing and investing decisions in presence of information asymmetry. It considers the extreme case where growth opportunities are not observable or verifiable for outside investors. Securities are hence undervalued, which in turn alters firms' investing and financing policies. The model quantifies the effect of information asymmetry and relates it directly to the underlying change in the production set. The numerical result shows that the investment distortion from information asymmetry is economically significant, especially for firms with large weights on growth opportunities. Information asymmetry also raises the default boundary and increases the expected bankruptcy cost. The optimal capital structure obtained in the paper is consistent with the pecking order theory. The cost of information asymmetry in terms of both the firm value and the information spread is substantial when the financial structure is optimized. |
