Premium
Tobin's Q , Debt Overhang, and Investment
Author(s) -
Hennessy Christopher A.
Publication year - 2004
Publication title -
the journal of finance
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 18.151
H-Index - 299
eISSN - 1540-6261
pISSN - 0022-1082
DOI - 10.1111/j.1540-6261.2004.00677.x
Subject(s) - debt overhang , debt , monetary economics , proxy (statistics) , economics , debt levels and flows , equity (law) , debt to gdp ratio , internal debt , external debt , econometrics , financial economics , finance , mathematics , statistics , political science , law
ABSTRACT Incorporating debt in a dynamic real options framework, we show that underinvestment stems from truncation of equity's horizon at default. Debt overhang distorts both the level and composition of investment, with underinvestment being more severe for long‐lived assets. An empirical proxy for the shadow price of capital to equity is derived. Use of this proxy yields a structural test for debt overhang and its mitigation through issuance of additional secured debt. Using measurement error‐consistent GMM estimators, we find a statistically significant debt overhang effect regardless of firms' ability to issue additional secured debt.