This paper investigates the interaction between investment decisions, company bankruptcy, and capital structure. We model young and innovative enterprises which face the possibility of making irreversible investments in R&D with uncertain returns, financed through risky debt. Uncertainty comes from two different sources: the technological success of the project and the return from investment. In an optimal investment setting, where uncertainty creates an incentive to delay investment decisions, we find the optimal threshold of entry (invest) and exit (bankruptcy), investigating both the case of infinite and finite debt maturity. We show that the potential loss of the investment option in the event of default, reduces the value of waiting and provides equity holders with an incentive to accelerate the investment. Thus the results of the model here presented seem to imply an active role for financial institutions but traditional loans may not be the most suitable solution to finance risky investment. In line with recent recommendations of the European Investment Bank (EIB, 2013), traditional bank lending might need to be reinforced through further instruments, such as loan guarantees and securitisation.

Marseguerra, G., Bragoli, D., Cortelezzi, F., The Effect of Risky Debt on R&D Investment, <<ECONOMIA POLITICA>>, 2014; XXXI (2): 149-172. [doi:10.1428/77435] [http://hdl.handle.net/10807/61275]

The Effect of Risky Debt on R&D Investment

Marseguerra, Giovanni;Bragoli, Daniela;Cortelezzi, Flavia
2014

Abstract

This paper investigates the interaction between investment decisions, company bankruptcy, and capital structure. We model young and innovative enterprises which face the possibility of making irreversible investments in R&D with uncertain returns, financed through risky debt. Uncertainty comes from two different sources: the technological success of the project and the return from investment. In an optimal investment setting, where uncertainty creates an incentive to delay investment decisions, we find the optimal threshold of entry (invest) and exit (bankruptcy), investigating both the case of infinite and finite debt maturity. We show that the potential loss of the investment option in the event of default, reduces the value of waiting and provides equity holders with an incentive to accelerate the investment. Thus the results of the model here presented seem to imply an active role for financial institutions but traditional loans may not be the most suitable solution to finance risky investment. In line with recent recommendations of the European Investment Bank (EIB, 2013), traditional bank lending might need to be reinforced through further instruments, such as loan guarantees and securitisation.
2014
Inglese
Marseguerra, G., Bragoli, D., Cortelezzi, F., The Effect of Risky Debt on R&D Investment, <<ECONOMIA POLITICA>>, 2014; XXXI (2): 149-172. [doi:10.1428/77435] [http://hdl.handle.net/10807/61275]
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Utilizza questo identificativo per citare o creare un link a questo documento: https://hdl.handle.net/10807/61275
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