Determinants of Corporate
Borrowing
Stewart C. Myers
Sloan School, M.I.T., Cambridge, MA 02139, U.S.A.
Received October 1976,
revised version received July 1977
Journal of Financial Economics 5 (1977) 147-175
North-Holland Publishing Company
QF04 892615 徐靜珊
892617 曾瓊萩
892629 賴書儀
Summary
Growth opportunity & call options
 Issuing risky debt & present market value
 Corporate borrowing & the proportion of
market value accounted by real options
 Other aspects of corporate borrowing

Introduction

Borrowing
-why not borrowing as much as possible
-tradeoff between tax advantage of debt
and costs of the suboptimal future
investment strategy
-other factors
Assumptions






Most firms are valued as going concern and the value
reflects an expectation of continued future investment
by the firm.
The investment is discretionary. The amount invested
depends on the net present values of opportunities as
they arise in the future.
V = VA + VG
There are no corporate taxes and no bankruptcy costs.
The firm’s managers act in the shareholders’ interest.
Capital markets are perfect and complete
Case1
A firm with no assets in place (VA =0 ) and only
one future investment opportunity.
The firm is initially all-equity financed.
Balance sheet at t=0
Value of growth
opportunity
0
VG
Value of the firm
V
VE
Value of debt
Value of equity
V
If it decides to invest, additional shares must be
issued to raise the required investment I.
Balance sheet at t=1
Value of newly
acquired asset V (s)
0
Value of debt
VE
Value of equity
Value of the firm V (s)
V(s)
Case2
The debt matures before the investment decision is made,
but after the true state of nature is revealed.
Balance sheet at t=0
Value of growth
opportunity
VD
Value of debt
VE
Value of equity
VG
Value of the firm
V
V
The firm raise the amount I and exercises its investment
option.
Balance sheet at t=1, given x (s) =1
Value of newly
acquired asset V (s)
Min[V(s),P] Value of debt
Max[0,V(s)-P] Value of equity
Value of the firm V (s)
V(s)



There is a definite limit, VD (max)
If the option exercised, min (V (s) ,P)=P
V is a monotonically decreasing function of P
Trade-off
Assets as call options
Bankruptcy cost
˙renegotiating the debt contract
1. Incentive:
If bondholders and shareholders find themselves in
the position where V<P, then it is in both interest to
renegotiate.
2. Disadvantages:
‧the direct costs of renegotiation
‧a costly duplication-it is doubtful that bondholders
could obtain an adequate estimate of V without
continual monitoring of the firm’s actions.
Liquidation cost &
reorganization cost
˙rewriting the contract
There would rarely be any objective basis for
judging whether the contract is breached, for
example, V(s) which is not objectively observed.
Impaired ability to conduct business
˙mediation
1. incentive :
When there are symptoms of financial distress
and suspicion, bondholders would call for an
impartial party to mediate.
2. disadvantage :
It is difficult to define when the mediator to be
called in.
Agency cost
*case 1:
shareholders may take a risk investment
˙Honesty is the best policy
1.Cause and effect:
Stockholders can play at the short-run expense of
bondholders, but in the long run, shareholders bear
the costs.
2.Voluntary forbearance is the simplest and best
solution to the investment incentive problem.
*Case2:
Shareholders may reject an investment with
positive NPV.
˙Honesty is the best policy
*case 3:
Shareholders may pay excess dividend.
˙Restrictions on dividends
Imperfections in Real Asset Markets


We think of the firm as composed of two
assets type: real assets, real option. And
we assume the market is not perfect and
complete.
Here, it is necessary that the value of a
growth option vanishes if it is not
exercised by the firm.


Case 1: if the real option is firm-specific
Case 2: if the real option is not firm-specific
Long-term borrowing

Assume a firm holding options wants to
exercise one of its option, at the same
time, it has bonds outstanding which is
mature at t :

Vt  VE ,t  VD ,t : the value of the firm
dVE dV dVD


dI
dI
dI
: an incremental investment on
the market value of equity
dV
 1 : the investment policy continues

dI
investing.


The value of the firm’s debt :


VD,t  ft Vt ,  2 V t 1 / Vt 



Therefore:

There is a transfer cost of value from
stockholders to bondholder:
dVE ,t
dV

dI
dI
  ft
1 
  Vt
  ft   t2 
 2 



I
t 
t 

dVt dVE ,t dV  ft  ft  t2
Zt 



 2
dI
dI
dI  Vt  t  I t
if Zt  0 , the investment exist.

 Assume  t  0 ,what happened?

2
t
Fig 4.
Spillover Effects &
Shift in Asset Risk

Spillover effects:


In brief, the investment at t will affect the value
of the firm at t-1 and t+1.
Shift in asset risk means that each
investment of the firm may face different
risk.

the impact of risky debt on the market value of
the firm is less for firms holding investment
options. In this sense we may observe risky
firms borrowing more than safe ones.
borrowing against a
portfolio of assets

One advantage of corporate diversification
is that diversified firms can borrow more.
We take two firms i, j holding two real
options.

First, we take a numerical example:
case A: Vi(s)+Vj(s)>Pi+Pj, it will be taken.
case B: Vi(s)+Vj(s)<Pi+Pj, it will not be taken.
Vi  j 
 Vi  s   V j  s   Pi  Pj
: the point to justify
investing or not.
 Vi  j  : the present value of option i in
portfolio with the other option j
 DVi  Vi  j   Vi  s  : diversification value
case
Conclusions

This paper is presented:
The firm’s growth opportunities could be views
as call option.
 If the firm want to issue debt, what is the place
to borrow?

 We
think that it’s case by case. Until now, we
introduce many situations. Each has different a
way doing.

The author thought that he’s still have many
things didn’t present yet.