Growth Option Exercise and Capital Structure. (27th October 2016)

• Record Type: Journal Article
• Authors: Purnanandam, Amiyatosh; Rajan, Uday
• Is Part Of: Review of finance. Volume 22:Number 1(2018)
• Page Start: 177
• Page End: 206
• Publication Date: 2016-10-27
• Subjects: Growth option -- Capital expenditure -- Signaling; Finance -- Europe -- Periodicals; Financiën; Finance; Periodicals; 332.09405
• DOI: 10.1093/rof/rfw062
• Languages: English
• ISSNs: 1572-3097

Abstract

Abstract: We document that firms decrease their leverage when they convert growth options into tangible assets. We argue that the act of growth option exercise decreases information asymmetry about the firm, which in turn reduces the relative cost of issuing information-sensitive securities such as equity. We show that leverage is negatively correlated with unexpected capital expenditure, our proxy for growth option conversion. The negative relationship becomes stronger when the information environment of a firm deteriorates following a reduction in analyst coverage after a brokerage house merger. Overall, our findings are contrary to standard trade-off and pecking order theories, but are consistent with recent work on signaling and growth options.