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. When this relationship is positive, firms prefer to mitigate the liquidity problem over the under-investment problem, and vice versa.
Sopranzetti (1999) examined how the sale of accounts receivable could be used to mitigate the severity of a firm's
underinvestment problem. The paper employed a two-period theoretical model that extended the technology developed in James (1989), who focused on banks' use of off-balance sheet financing, such as standby letters of credit or commercial loan sales, to the case of selling accounts receivable.
Stulz (1990) and Myers and Majluf (1984) present models to demonstrate the
underinvestment problem resulting from insufficient cash reserves.
"
underinvestment problem" (throughout the Article we will use
(1984) analytically demonstrate that in the presence of information asymmetry a firm may pass up positive NPV projects due to costly external financing, thus creating an
underinvestment problem. Fazzari et al.
This means that part of the benefit of investing goes to the creditors, which is what creates the debt-overhang
underinvestment problem. By matching the maturities of its assets and liabilities, the firm is effectively reducing the debt-overhang distortion.
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.
For example, by considering the relation among hedging, leverage, and investment, Ross (1996) argues that hedging to increase leverage may not mitigate the
underinvestment problem, since if firms increase debt capacity after hedging then this higher leverage increases the agency cost of debt that in turn leads to the incentive for underinvestment.
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.
On the other hand, an
underinvestment problem is expected to be more pronounced for high-growth firms.
