Johnson (2003) points out that the relationship between debt term and debt will depend on the trade-off between the preference to mitigate liquidity risks or the
underinvestment problem.
The
underinvestment problem was taken as serious for high risk projects; therefore the model predicted that receivable sales would be more likely for low risk, high credit-quality receivable.
Stulz (1990) and Myers and Majluf (1984) present models to demonstrate the
underinvestment problem resulting from insufficient cash reserves.
First, the study extends prior literature and investigates whether the content of corporate disclosure plays a role in mitigating the
underinvestment problem.
This means that part of the benefit of investing goes to the creditors, which is what creates the debt-overhang
underinvestment problem.
Finally, the underinvestment hypothesis, developed by Bodie and Taggart (1978) and Barnea, Haugena, and Senbet (1980), demonstrates that the Myers' (1977)
underinvestment problem can be resolved with a call provision.
Ross' argument implies that firms with high growth opportunities are more likely to hedge to mitigate the
underinvestment problem and are less likely to increase debt capacity.
Any future replacement for the ITS would likely experience the same
underinvestment problem.
But, more importantly, implementing a policy that rewards the diffusion of technology can create new incentives for additional spending on research and development, thereby potentially solving the
underinvestment problem resulting from market failure.
This is the
underinvestment problem identified by Myers (1977, p.
High-growth opportunity firms are more likely to face an
underinvestment problem compared with low-growth opportunity firms and, thus, the negative effect of longer debt maturity on investment should be stronger for high-growth opportunity firms.
In both cases an
underinvestment problem results if the marginal agency cost is positive.
