We model the expansion decision of a levered firm. Straight debt distorts both timing and scaling: the firm invests less and later than its all-equity financed counterpart. The inclusion of performance sensitivity in the debt contract mitigates such distortions. Moreover, performance sensitivity...

This study identifies a tax disadvantage of debt that arises when a firm’s business model fails and it liquidates its assets at a loss. If the outstanding debt is greater than or equal to the salvage value of the firm’s assets, the firm will not have assets to generate income to use the loss...