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A Simple Model of the Firm Life Cycle

Author

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  • Klaus REINER SCHENK-HOPPE

    (University of Leeds)

  • Urs SCHWERI

    (University of Zurich)

Abstract

This paper presents a simple model of the firm life cycle that cap- tures several stylized economic and financial features which usually require considerably more demanding approaches. We study the opti- mal capital accumulation policy of a financially constrained firm whose revenue is subject to an additive shock. Earnings can be paid as div- idends or reinvested with the goal to maximize shareholder value. In our model, the optimal policy of firms is to reinvest earnings (rather than paying dividends) when small, hold precautionary savings, and grow larger than is socially optimal. Smaller firms also have a higher bankruptcy risk and a more volatile market value than larger firms. We observe the leverage effect and excess returns of value stocks. In the presence of business cycles, investment and initial public offer- ings are pro-cyclical, the default probability is counter-cyclical, and monetary policy increases excess capital holdings but otherwise has a negligible impact.

Suggested Citation

  • Klaus REINER SCHENK-HOPPE & Urs SCHWERI, 2010. "A Simple Model of the Firm Life Cycle," Swiss Finance Institute Research Paper Series 10-39, Swiss Finance Institute.
    • Handle: RePEc:chf:rpseri:rp1039
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    More about this item

    Keywords

    Firm life cycle; financing constraints; optimal dividend and investment policy; bankruptcy; business cycle.;
    All these keywords.

    JEL classification:

    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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