Les Cahiers de Recherche - HEC Paris
Marc CHESNEY and Rajna GIBSON-ASNER
The Investment Policy and the Pricing of Equity in a Levered Firm: a Re-examination of the contingent claims Valuation Approach
Abstract: 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 which and quantifies the asset substitution
problem previously acknowledged by the agency literature.
Keywords: agency problems; asset substitution; contingent claim; down-and-out call option; capital structure; leverage; risk incentives; (follow links to similar papers)
JEL-Codes: D92; G10; G12; G31; (follow links to similar papers)
13 pages, April 1, 1999
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