Stockholder-Bondholder Conflict : Application of Binomial Option Pricing Methodology

This paper discusses how the stockholder-bondholder conflict can be analyzed using the binomial option pricing model. Although the potential conflicts between stockholders and bondholders are recognized and discussed in most intermediate corporate finance textbooks, these textbooks, generally do not illustrate the valuation of the relevant options involved in those situations; this article fills that void. Further, it takes explicit account of financial distress of the firm - which is usually the cause of the conflict - in analyzing the underinvestment and asset substitution problems