Determinants of Corporate Borrowing Stewart C. Myers Sloan School, M.I.T., Cambridge, MA 02139, U.S.A. Received October 1976, revised version received July 1977 Journal of Financial Economics 5 (1977) North-Holland Publishing Company QF 徐靜珊 QF 徐靜珊 曾瓊萩 曾瓊萩 賴書儀 賴書儀

Summary Growth opportunity & call options Growth opportunity & call options Issuing risky debt & present market value Issuing risky debt & present market value Corporate borrowing & the proportion of market value accounted by real options Corporate borrowing & the proportion of market value accounted by real options Other aspects of corporate borrowing Other aspects of corporate borrowing

Introduction Borrowing Borrowing -why not borrowing as much as possible -why not borrowing as much as possible -tradeoff between tax advantage of debt -tradeoff between tax advantage of debt and costs of the suboptimal future and costs of the suboptimal future investment strategy investment strategy -other factors -other factors

Assumptions Most firms are valued as going concern and the value reflects an expectation of continued future investment by the firm. Most firms are valued as going concern and the value reflects an expectation of continued future investment by the firm. The investment is discretionary. The amount invested depends on the net present values of opportunities as they arise in the future. The investment is discretionary. The amount invested depends on the net present values of opportunities as they arise in the future. V = V A + V G V = V A + V G There are no corporate taxes and no bankruptcy costs. There are no corporate taxes and no bankruptcy costs. The firm’s managers act in the shareholders’ interest. The firm’s managers act in the shareholders’ interest. Capital markets are perfect and complete Capital markets are perfect and complete

Case1 A firm with no assets in place (V A =0 ) and only one future investment opportunity. The firm is initially all-equity financed. Balance sheet at t=0 Value of growth opportunity V G 0 Value of debt V E Value of equity Value of the firm VV If it decides to invest, additional shares must be issued to raise the required investment I. Balance sheet at t=1 Value of newly acquired asset V (s) 0 Value of debt V E Value of equity Value of the firm V (s)V(s)

Case2 The debt matures before the investment decision is made, but after the true state of nature is revealed. Balance sheet at t=0 Value of growth opportunity V G V D Value of debt V E Value of equity Value of the firm VV The firm raise the amount I and exercises its investment option. Balance sheet at t=1, given x (s) =1 Value of newly acquired asset V (s) Min[V(s),P] Value of debt Max[0,V(s)-P] Value of equity Value of the firm V (s)V(s)

There is a definite limit, V D (max) There is a definite limit, V D (max) If the option exercised, min (V (s),P)=P If the option exercised, min (V (s),P)=P V is a monotonically decreasing function of P V is a monotonically decreasing function of P

Trade-off

Assets as call options

Bankruptcy cost ˙renegotiating the debt contract 1. Incentive: 1. Incentive: If bondholders and shareholders find themselves in If bondholders and shareholders find themselves in the position where V<P, then it is in both interest to the position where V<P, then it is in both interest to renegotiate. renegotiate. 2. Disadvantages: 2. Disadvantages: ‧ the direct costs of renegotiation ‧ a costly duplication-it is doubtful that bondholders ‧ a costly duplication-it is doubtful that bondholders could obtain an adequate estimate of V without could obtain an adequate estimate of V without continual monitoring of the firm’s actions. continual monitoring of the firm’s actions.

Liquidation cost & reorganization cost ˙rewriting the contract There would rarely be any objective basis for There would rarely be any objective basis for judging whether the contract is breached, for judging whether the contract is breached, for example, V(s) which is not objectively observed. example, V(s) which is not objectively observed.

Impaired ability to conduct business ˙mediation 1. incentive : 1. incentive : When there are symptoms of financial distress When there are symptoms of financial distress and suspicion, bondholders would call for an and suspicion, bondholders would call for an impartial party to mediate. impartial party to mediate. 2. disadvantage : 2. disadvantage : It is difficult to define when the mediator to be It is difficult to define when the mediator to be called in. called in.

Agency cost *case 1: shareholders may take a risk investment shareholders may take a risk investment ˙Honesty is the best policy ˙Honesty is the best policy 1.Cause and effect: 1.Cause and effect: Stockholders can play at the short-run expense of Stockholders can play at the short-run expense of bondholders, but in the long run, shareholders bear bondholders, but in the long run, shareholders bear the costs. the costs. 2.Voluntary forbearance is the simplest and best 2.Voluntary forbearance is the simplest and best solution to the investment incentive problem. solution to the investment incentive problem.

*Case2: Shareholders may reject an investment with Shareholders may reject an investment with positive NPV. positive NPV. ˙Honesty is the best policy ˙Honesty is the best policy *case 3: Shareholders may pay excess dividend. Shareholders may pay excess dividend. ˙Restrictions on dividends ˙Restrictions on dividends

Imperfections in Real Asset Markets We think of the firm as composed of two assets type: real assets, real option. And we assume the market is not perfect and complete. We think of the firm as composed of two assets type: real assets, real option. And we assume the market is not perfect and complete. Here, it is necessary that the value of a growth option vanishes if it is not exercised by the firm. Here, it is necessary that the value of a growth option vanishes if it is not exercised by the firm. Case 1: if the real option is firm-specific Case 1: if the real option is firm-specific Case 2: if the real option is not firm-specific Case 2: if the real option is not firm-specific

Long-term borrowing Assume a firm holding options wants to exercise one of its option, at the same time, it has bonds outstanding which is mature at t : Assume a firm holding options wants to exercise one of its option, at the same time, it has bonds outstanding which is mature at t : : the value of the firm : the value of the firm : an incremental investment on the market value of equity : an incremental investment on the market value of equity : the investment policy continues investing. : the investment policy continues investing.

The value of the firm’s debt : The value of the firm’s debt : Therefore: Therefore: There is a transfer cost of value from stockholders to bondholder: There is a transfer cost of value from stockholders to bondholder: if, the investment exist. if, the investment exist. Assume,what happened? Assume,what happened?

Fig 4.

Spillover Effects & Shift in Asset Risk Spillover effects: Spillover effects: In brief, the investment at t will affect the value of the firm at t-1 and t+1. In brief, the investment at t will affect the value of the firm at t-1 and t+1. Shift in asset risk means that each investment of the firm may face different risk. Shift in asset risk means that each investment of the firm may face different risk. the impact of risky debt on the market value of the firm is less for firms holding investment options. In this sense we may observe risky firms borrowing more than safe ones. the impact of risky debt on the market value of the firm is less for firms holding investment options. In this sense we may observe risky firms borrowing more than safe ones.

borrowing against a portfolio of assets One advantage of corporate diversification is that diversified firms can borrow more. We take two firms i, j holding two real options. One advantage of corporate diversification is that diversified firms can borrow more. We take two firms i, j holding two real options. First, we take a numerical example: First, we take a numerical example: case A: V i (s)+V j (s)>P i +P j, it will be taken. case A: V i (s)+V j (s)>P i +P j, it will be taken. case B: V i (s)+V j (s)<P i +P j, it will not be taken. case B: V i (s)+V j (s)<P i +P j, it will not be taken.

: the point to justify investing or not. : the point to justify investing or not. : the present value of option i in portfolio with the other option j : the present value of option i in portfolio with the other option j : diversification value : diversification value

case

Conclusions This paper is presented: This paper is presented: The firm’s growth opportunities could be views as call option. The firm’s growth opportunities could be views as call option. If the firm want to issue debt, what is the place to borrow? If the firm want to issue debt, what is the place to borrow? We think that it’s case by case. Until now, we introduce many situations. Each has different a way doing. We think that it’s case by case. Until now, we introduce many situations. Each has different a way doing. The author thought that he’s still have many things didn’t present yet. The author thought that he’s still have many things didn’t present yet.