Temporal Resolution of Uncertainty, the Investment Policy of Levered Firms and Corporate Debt
Yields
October 26, 1999
Alexander Reisz
ABSTRACT
This paper attempts to link the agency literature (concerned with whether debt will trigger underinvestment incentives
or risk-shifting behavior) with the one dealing with temporal resolution of uncertainty. To the best of our knowledge,
apart from one article by John and Ronen (1990), there is no research article linking the two literatures.
We are concerned here with how the product/input market influences deviations from the optimal investment policy,
in particular to what extent the speed of resolution of uncertainty of the industry in which a given firm operates
affects the risk-shifting behavior of a shareholder-aligned manager. We assume that investors are risk neutral
and that the return on the risky technology is normally distributed. It is then shown that the pattern of temporal
resolution of uncertainty monotonically affects risk shifting as well as bond yields, even after contracts mitigating
deviations from optimal investment policy have been written; empirical implications are derived and discussed.
Subject: Corporate Finance/Capital Structure and Dividend Policy, Valuation
Classification: theoretical
Reisz: (212) 998-0344 areisz@stern.nyu.edu
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