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Can real options explain financing behavior?

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  • Tserlukevich, Yuri
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    Abstract

    Trade-off models commonly invoke financial transaction costs in order to explain observed leverage fluctuations. This paper offers an alternative explanation based on real options. The model is frictionless on the financing side but incorporates irreversibility and fixed costs of investment. Results obtained from simulating the model are broadly consistent with observed financing patterns. Market leverage ratios are negatively related to profitability, mean-reverting, and depend on past stock returns. The gradual and lumpy leverage adjustments can occur in the absence of financial transaction costs. This evidence shows that incorporating real frictions into structural models increases their explanatory power.

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    Bibliographic Info

    Article provided by Elsevier in its journal Journal of Financial Economics.

    Volume (Year): 89 (2008)
    Issue (Month): 2 (August)
    Pages: 232-252

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    Handle: RePEc:eee:jfinec:v:89:y:2008:i:2:p:232-252

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    Web page: http://www.elsevier.com/locate/inca/505576

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    Cited by:
    1. N. Letifi & J.-L. Prigent, 2014. "On the debt capacity of growth and decay options," Working Papers 2014-391, Department of Research, Ipag Business School.
    2. DeAngelo, Harry & DeAngelo, Linda & Whited, Toni M., 2011. "Capital structure dynamics and transitory debt," Journal of Financial Economics, Elsevier, Elsevier, vol. 99(2), pages 235-261, February.
    3. Agliardi, Elettra & Koussis, Nicos, 2013. "Optimal capital structure and the impact of time-to-build," Finance Research Letters, Elsevier, Elsevier, vol. 10(3), pages 124-130.
    4. Miglo, Anton, 2010. "The Pecking Order, Trade-off, Signaling, and Market-Timing Theories of Capital Structure: a Review," MPRA Paper 46691, University Library of Munich, Germany, revised 2013.
    5. Letifi, N. & Prigent, J.-L., 2014. "On the optimality of funding and hiring/firing according to stochastic demand: The role of growth and shutdown options," Economic Modelling, Elsevier, vol. 40(C), pages 410-422.
    6. Bazdresch, Santiago, 2013. "The role of non-convex costs in firms' investment and financial dynamics," Journal of Economic Dynamics and Control, Elsevier, vol. 37(5), pages 929-950.
    7. Nishihara, Michi & Shibata, Takashi, 2013. "The effects of external financing costs on investment timing and sizing decisions," Journal of Banking & Finance, Elsevier, vol. 37(4), pages 1160-1175.
    8. Dudley, Evan, 2012. "Capital structure and large investment projects," Journal of Corporate Finance, Elsevier, vol. 18(5), pages 1168-1192.
    9. Kit Wong, 2010. "On the neutrality of debt in investment intensity," Annals of Finance, Springer, vol. 6(3), pages 335-356, July.

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