Selling accounts receivable and the underinvestment problem

Firms plagued by the Myers underinvestment problem can mitigate the severity of underinvestment by selling their high credit-quality accounts receivable. This paper solves for the break-point level of receivable credit-quality (that is, the level of credit-quality such that the sale of receivables whose quality is greater than this level will mitigate the magnitude of underinvestment,) and demonstrates that this break-point is an increasing function of the riskiness of the firms' debt. The predictions of this model have broad implications for the nature of factoring and receivable securitization contracts.