and Rajna GIBSON-ASNER
Rajna GIBSON-ASNER: Ecole des HEC, Universite de Lausanne, Postal: 1015 Lausanne, Switzerland
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.
13 pages, April 1, 1999
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