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Journal of Finance Vol. 59 No. 4 2004

Tobin's Q, Debt Overhang, and Investment

Christopher A. Hennessy

Christopher A. Hennessy is at Walter A. Haas School of Business, University of California at Berkeley. I am grateful to Jonathan Berk, Terry Hendershott, Amnon Levy, Ben Bernanke, Jose Scheinkman, and especially my dissertation adviser Patrick Bolton. Thanks to Toni Whited and Timothy Erickson for p

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.

DOI
10.1111/j.1540-6261.2004.00677.x
Volume
59
Issue
4
Pages
1717-1742
Language
en
Sources
bibtex:phds-export.bib openalex crossref

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