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Evaluating Flexibility in Small Firm Financing

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Author Info

  • Andrey Pavlov

    (Simon Fraser University)

  • Panikkos Poutziouris

    (University of Manchester Institute of Science and Technology, Manchester University Consortium)

  • Khaled Soufani

    (Concordia University)

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    Abstract

    The choice of financing source is particularly difficult for a small firm due to the high uncertainty about future liquidity requirements. We show that the techniques of continuous time arbitrage and stochastic control theory may be used not only to value such firms but also to determine the optimal financing policies. In particular, we investigate the choice between liquid, but more expensive, forms of financing and restrictive, but cheaper, sources of capital. In addition to developing an optimal financing policy for a typical firm, we estimate the value of flexibility in a financing arrangement. This, in turn, provides a rational explanation for the otherwise surprisingly high levels of flexible financing used by small firms. Beyond small firm management, our findings have important implications for financial institutions and regulators.

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    Bibliographic Info

    Article provided by Pepperdine University, Graziadio School of Business and Management in its journal Journal of Entrepreneurial Finance and Business Ventures.

    Volume (Year): 9 (2004)
    Issue (Month): 1 (Spring)
    Pages: 73-97

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    Handle: RePEc:pep:journl:v:9:y:2004:i:1:p:73-97

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    Web page: http://bschool.pepperdine.edu/jef
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    Related research

    Keywords: Small Firm Financing; Small Business; Flexibility;

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    References

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    1. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    2. Shyam-Sunder, Lakshmi & C. Myers, Stewart, 1999. "Testing static tradeoff against pecking order models of capital structure," Journal of Financial Economics, Elsevier, vol. 51(2), pages 219-244, February.
    3. Soufani, Khaled, 2002. "On the determinants of factoring as a financing choice: evidence from the UK," Journal of Economics and Business, Elsevier, vol. 54(2), pages 239-252.
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    Cited by:
    1. George W. Blazenko & Andrey D. Pavlov, 2010. "Investment Timing for New Business Ventures," Journal of Entrepreneurial Finance, Pepperdine University, Graziadio School of Business and Management, vol. 14(3), pages 37-68, Fall.

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