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Corporate Financial and Investment Policies when Future Financing is not Frictionless

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Author Info
Heitor Almeida
Murillo Campello
Michael S. Weisbach

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Abstract

Much of corporate finance is concerned with the impact of financing constraints on firms. However, the literature on financing constraints largely ignores the intertemporal implications of those constraints; in particular, how future financing constraints affect current investment decisions. We present a model in which future financing constraints lead firms to have a current preference for investments with shorter payback periods, investments with less risk, and investments that utilize more liquid/pledgeable assets. The model has a host of implications in different areas of corporate finance, including firms' capital budgeting rules, risk-taking behavior, capital structure choices, hedging strategies, and cash management policies. We show how a number of patterns reported in the empirical literature can be reconciled and interpreted in light of the intertemporal optimization problem firms solve when they face costly external financing. For example, contrary to Jensen and Meckling (1976), we show that firms may reduce rather than increase risk when leverage increases exogenously. Furthermore, firms in economies with less developed financial markets will not only take different quantities of investment, but will also take different kinds of investment (safer, short-term projects that are potentially less profitable). We also point out to several predictions that have not been empirically examined. For example, our model predicts that investment safety and liquidity are complementary: constrained firms are specially likely to distort the risk profile of their most liquid investments.

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Paper provided by National Bureau of Economic Research, Inc in its series NBER Working Papers with number 12773.

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Date of creation: Dec 2006
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Handle: RePEc:nbr:nberwo:12773

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Find related papers by JEL classification:
G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Investment Policy
G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Capital and Ownership Structure

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Cited by:
(explanations, Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.)

  1. Brandon Julio & Woojin Kim & Michael Weisbach, 2007. "What Determines the Structure of Corporate Debt Issues?," NBER Working Papers 13706, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  2. Isil Erel & Brandon Julio & Woojin Kim & Michael Weisbach, 2009. "Market Conditions and the Structure of Securities," NBER Working Papers 14952, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
    Other versions:
  3. Patrick Bolton & Hui Chen & Neng Wang, 2009. "A Unified Theory of Tobin's q, Corporate Investment, Financing, and Risk Management," NBER Working Papers 14845, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
  4. Joshua Rauh, 2007. "Risk Shifting versus Risk Management: Investment Policy in Corporate Pension Plans," NBER Working Papers 13240, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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