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Contribution Details
| Type | Journal Article |
| Scope | Discipline-based scholarship |
| Title | The investment policy and the pricing of equity in a levered firm: a re-examination of the 'contingent claims' valuation approach |
| Organization Unit | |
| Authors |
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| Item Subtype | Original Work |
| Refereed | Yes |
| Status | Published in final form |
| Language |
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| Journal Title | The European journal of finance |
| Publisher | Taylor & Francis |
| Geographical Reach | international |
| ISSN | 1351-847X |
| Volume | 5 |
| Number | 2 |
| Page Range | 95 - 107 |
| Date | 1999 |
| Abstract Text | In this study we re-examine the pricing of equity and the risk incentives of shareholders in levered firms. We derive a down-and-out call equity valuation model which rests on the assumption that shareholders choose the optimal investment and asset returns' volatility as a function of current leverage. Contrarily to the Black and Scholes framework where, irrespective of the firm's leverage, they would always select infinite volatility projects, here the more deep out-of-the-money the shareholders' claim, the greater their incentives to select riskier investment projects. The model is thus consistent with and quantifies the asset substitution problem previously acknowledged by the agency literature. |
| Digital Object Identifier | 10.1080/135184799337118 |
| Other Identification Number | merlin-id:13228 |
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| Keywords | Agency problems, asset substitution, contingent claim, down-and-out call option, capital structure, leverage, risk incentives |