Levered Corporate Investment And Financing Decisions Based On Real Options Theory

The scientific investment and financing decisions are the core of the survival and development of enterprises, and the corporate investment and financing strategies generally include three aspects, that are investment timing n investment capacity and capital structure. The three decisions are an interactive system, and if we ignore the characteristics of interactive relationship, it will result in the error of corporate decisions. Therefore, we consider the investment and financing problems of the levered enterprise. Based on real-options theory, equilibrium pricing, dynamic programming and stochastic analysis, we set up several structure models to analyze the equilibrium pricing of equity, debt and real options. We explore the levered enterprise how to decide investment timing, investment capacity and capital structure under agency conflicts and analyze the relationship among them, and then contrast to the investment decisions of all-equity financing enterprise.First of all, we consider the investment timing?investment capacity and capital structure choice simultaneously in presence of stockholder-bondholder conflicts and debt issuance costs. Based on the assumptions that the cash flow follows Geometric Brownian motion and investment capacity satisfies a Cobb-Dauglas production function, we derive the relation among investment timing, investment capacity and capital structure through equilibrium pricing theory and real-options approach. The numerical results show that the investment timing and investment capacity of levered enterprise are positively related under given capital structure; If a firm earns less/more whenever the market is boom/recession, investment will be accelerated and smaller in investment capacity Ndebt financing capacity and a corresponding smaller in leverage ratio; When the marginal cost of debt issuance is close to tax rate, investment decisions of levered enterprise are similar to an all-equity financing enterprise; An equity-maximizing firm exercises the option too early relative to a value-maximizing policy, which results in a decrease in investment capacityn debt financing capacity?firm value and a corresponding decrease in leverage ratio.Secondly, the interests of manager and shareholder or enterprise are usually regarded as conformity in the literature about investment and financing decisions. However, the presence of information asymmetry in the reality results in the interests conflicts of manager and shareholder or enterprise. For this reason, we relax this assumption and study corporate investment and financing decisions under principal-agent conflicts by the means of real options. We consider the investment timing ?investment capacity and capital structure choice simultaneously when corporate investment and financing decisions will be made by a self-interested manager. Then we analyze how the manager's ownership stake and project risk impact on inefficient investment and financing decisions. The numerical results show that the investment timing and investment capacity of levered enterprise are negatively related under given capital structure; The manager will accelerate the investment and increase the investment capacity compared to an unlevered enterprise; Leverage ratio and yield spread of debt exhibit a U-shaped pattern against the manager's ownership stake; A greater manager's ownership stake makes investment earlier and results in an increase in investment capacity and debt financing capacity, and a decrease in agency costs; An increase in project risk delays investment and leads to an increase in investment capacity s debt financing capacity and yield spread of debt, a sharp increase in agency costs, and a decrease in leverage ratio.