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Financing Constraints, Irreversibility, and Investment Dynamics

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  • Andrea Caggese

Abstract

We develop a model of an industry with many heterogeneous firms that face both financing constraints and irreversibility constraints. The financing constraint implies that firms cannot borrow unless the debt is secured by collateral; the irreversibility constraint that they can only sell their fixed capital by selling their business. We use this model to examine the cyclical behavior of aggregate fixed investment, variable capital investment, and output in the presence of persistent idiosyncratic and aggregate shocks. Our model yields three main results. First, the effect of the irreversibility constraint on fixed capital investment is reinforced by the financing constraint. Second, the effect of the financing constraint on variable capital investment is reinforced by the irreversibility constraint. Finally, the interaction between the two constraints is key for explaining why input inventories and material deliveries of US manufacturing firms are so volatile and procyclical, and also why they are highly asymmetrical over the business cycle.

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Bibliographic Info

Paper provided by Barcelona Graduate School of Economics in its series Working Papers with number 53.

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Date of creation: Jun 2001
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Handle: RePEc:bge:wpaper:53

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Keywords: Financing constraints; irreversibility; investment;

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References

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  1. Thomas Cooley & Ramon Marimon & Vincenzo Quadrini, 2003. "Aggregate Consequences of Limited Contract Enforceability," NBER Working Papers 10132, National Bureau of Economic Research, Inc.
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Cited by:
  1. Andrea Caggese, 2003. "Testing Financing Constraints on Firm Investment Using Variable Capital," Working Papers 65, Barcelona Graduate School of Economics.
  2. Julia K. Thomas & Aubhik Khan, 2010. "Credit Shocks and Aggregate Fluctuations in an Economy with Production Heterogeneity," 2010 Meeting Papers 801, Society for Economic Dynamics.
  3. McGee, M. Kevin, 2010. "Twice constrained investment under uncertainty: A mixed time model," Research in Economics, Elsevier, vol. 64(2), pages 110-120, June.
  4. Chatelain, Jean-Bernard & Ralf, Kirsten & Amable, Bruno, 2010. "Patents as Collateral," EconStor Open Access Articles, ZBW - German National Library of Economics.
  5. Richard Holt, 2007. "Investment, irreversibility and financial imperfections: the rush to invest and the option to wait," Economics Bulletin, AccessEcon, vol. 5(10), pages 1-10.
  6. Rainer Niemann & Caren Sureth, 2011. "The Impact of Differential Capital Income Taxation on the Value of Risky Projects," Economics Bulletin, AccessEcon, vol. 31(2), pages 1047-1054.
  7. Julia K. Thomas & Aubhik Khan, 2009. "Collateral constraints, capital specificity and the distribution of production: the role of real and financial frictions in aggregate fluctuations," 2009 Meeting Papers 1133, Society for Economic Dynamics.
  8. Alessandra Guariglia & John Tsoukalas & Serafeim Tsoukas, . "Investment, irreversibility, and financing constraints in transition economies," Discussion Papers 10/03, University of Nottingham, School of Economics.

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