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On the Role of External Financing Costs in Optimal Investment Decisions

Author

Listed:
  • Mohamed Belhaj

    (Centrale Marseille (Aix-Marseille School of Economics), CNRS & EHESS)

  • Nataliya Klimenko

    (Centrale Marseille (Aix-Marseille School of Economics), CNRS & EHESS.)

Abstract

This paper brings into focus a link between the investment and financing decisions of a firm which has an access to costly debt financing. Our analysis shows that lump-sum debt issuance costs play a prominent role in a determination of the optimal investment strategy. Faced with larger lump-sum debt issuance costs, a firm will optimally set up a higher-scale investment project in order to "compensate" dead-weight financing costs by higher return. Moreover, in the presence of lump-sum debt issuance costs, the optimal investment scale of financially constrained firms exhibits an inverted U-shaped relationship with the firm's borrowing capacity, so that relatively more/less constrained firms will realize smaller investment projects, whereas firms with an intermediate borrowing capacity will undertake larger investment.

Suggested Citation

  • Mohamed Belhaj & Nataliya Klimenko, 2012. "On the Role of External Financing Costs in Optimal Investment Decisions," AMSE Working Papers 1241, Aix-Marseille School of Economics, France.
    • Handle: RePEc:aim:wpaimx:1241
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    References listed on IDEAS

    as
    1. Lyandres, Evgeny, 2007. "Costly external financing, investment timing, and investment-cash flow sensitivity," Journal of Corporate Finance, Elsevier, vol. 13(5), pages 959-980, December.
    2. 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.
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    5. Cleary, Sean & Povel, Paul & Raith, Michael, 2007. "The U-Shaped Investment Curve: Theory and Evidence," Journal of Financial and Quantitative Analysis, Cambridge University Press, vol. 42(1), pages 1-39, March.
    6. Guariglia, Alessandra, 2008. "Internal financial constraints, external financial constraints, and investment choice: Evidence from a panel of UK firms," Journal of Banking & Finance, Elsevier, vol. 32(9), pages 1795-1809, September.
    7. Kit Wong, 2010. "On the neutrality of debt in investment intensity," Annals of Finance, Springer, vol. 6(3), pages 335-356, July.
    8. repec:adr:anecst:y:2009:i:93-94:p:11 is not listed on IDEAS
    9. Stefan Hirth & Marliese Uhrig-Homburg, 2010. "Investment Timing when External Financing is Costly," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 37(7-8), pages 929-949.
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    Full references (including those not matched with items on IDEAS)

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    More about this item

    Keywords

    Real options; investment intensity; debt issuance costs; credit constraints.;
    All these keywords.

    JEL classification:

    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation

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