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Optimal Investment by Financially Xenophobic Managers

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Abstract

Case studies show that corporate managers seek financial independence to avoid interference by outside financiers. We incorporate this financial xenophobia as a fixed cost in a simple dynamic model of financing and investment. To avoid refinancing in the future, the firm alters its behavior depending on the extent of its financial xenophobia and the realization of a revenue shock. With a sufficiently adverse shock, the firm holds no liquidity. Otherwise, the firm precautionarily saves and holds both liquidity and external finance. Investment always responds to neoclassical fundamentals, but responds to cash flow only when the firm holds no liquidity.

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File URL: http://econ.hunter.cuny.edu/wp-content/uploads/sites/6/RePEc/papers/HunterEconWP02-4.pdf
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Bibliographic Info

Paper provided by Hunter College Department of Economics in its series Economics Working Paper Archive at Hunter College with number 02/4.

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Length: 32 pages
Date of creation: 2000
Date of revision: 2001
Handle: RePEc:htr:hcecon:02/4

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Keywords: Investment; Corporate Cash Holdings; Liquidity; Cash Flow;

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  1. Hart, O. & Moore, J., 1989. "Default And Renegotiation: A Dynamic Model Of Debt," Working papers 520, Massachusetts Institute of Technology (MIT), Department of Economics.
  2. Ramey, Garey & Watson, Joel, 1997. "Contractual Fragility, Job Destruction, and Business Cycles," The Quarterly Journal of Economics, MIT Press, vol. 112(3), pages 873-911, August.
  3. Berglof, Erik & von Thadden, Ernst-Ludwig, 1994. "Short-Term versus Long-Term Interests: Capital Structure with Multiple Investors," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 1055-84, November.
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  5. Hart, Oliver & Moore, John, 1994. "A Theory of Debt Based on the Inalienability of Human Capital," The Quarterly Journal of Economics, MIT Press, vol. 109(4), pages 841-79, November.
  6. Adam Brandenburger & Ben Polak, 1996. "When Managers Cover Their Posteriors: Making the Decisions the Market Wants to See," RAND Journal of Economics, The RAND Corporation, vol. 27(3), pages 523-541, Autumn.
  7. Opler, Tim & Pinkowitz, Lee & Stulz, Rene & Williamson, Rohan, 1999. "The determinants and implications of corporate cash holdings," Journal of Financial Economics, Elsevier, vol. 52(1), pages 3-46, April.
  8. Ben Bernanke & Mark Gertler & Simon Gilchrist, 1998. "The Financial Accelerator in a Quantitative Business Cycle Framework," NBER Working Papers 6455, National Bureau of Economic Research, Inc.
  9. Burkart, Mike & Gromb, Denis & Panunzi, Fausto, 1997. "Large Shareholders, Monitoring, and the Value of the Firm," The Quarterly Journal of Economics, MIT Press, vol. 112(3), pages 693-728, August.
  10. Joao F. Gomes, 2001. "Financing Investment," American Economic Review, American Economic Association, vol. 91(5), pages 1263-1285, December.
  11. Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
  12. Shleifer, Andrei & Vishny, Robert W, 1992. " Liquidation Values and Debt Capacity: A Market Equilibrium Approach," Journal of Finance, American Finance Association, vol. 47(4), pages 1343-66, September.
  13. Stewart C. Myers, 2000. "Outside Equity," Journal of Finance, American Finance Association, vol. 55(3), pages 1005-1037, 06.
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