Fixed Life Projects: Agency conflicts and optimal leverage

In this paper we analyse a model of the conflicts between equityholders and debtholders regarding the optimal exercise moment for investment in a firm whose only asset is a concession contract. This setting reflects the reality of, not only traditional concessions, but also image rights and audiovisual contracts. Our results support the coexistence of two different incentives (overinvestment and underinvestment) in one single type of real flexibility (option to invest). We show how overinvestment incentives clearly dominate underinvestment incentives, in terms of their impact in the option value, and show how they tend to occur at or close to maturity of the investment option. We present competing predictions for the size of the agency costs and optimal debt levels, under different market conditions and for different asset characteristics, and reiterate the impact of the agency conflicts in lowering optimal debt levels. Our results also show how different debt repayment schedules optimize the value of the firm operating the concession, even if in some cases the optimal schedule represents the one more sensitive to agency costs.