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Investment timing with fixed and proportional costs of external financing

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Author Info

  • Michi Nishihara

    ()
    (Graduate School of Economics, Osaka University)

  • Takashi Sshibata

    ()
    (Graduate School of Social Sciences, Tokyo Metropolitan University)

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    Abstract

    We develop a dynamic model in which a firm exercises an option to expand production with cash balance and costly external funds. While related papers explain their results only by numerical examples, we analytically prove the following results. In the presence of only a proportional cost of external financing, the firm with more cash balance invests earlier; however, the presence of both proportional and fixed costs leads to a non-monotonic relation between the investment time and cash balance. The firm with more cash balance invests later to save a fixed cost, particularly when the cash balance is close to the investment cost. Our results can potentially account for a variety of empirical results concerning the relation between investment volume and financing constraints.

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    File URL: http://www2.econ.osaka-u.ac.jp/library/global/dp/1129.pdf
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    Bibliographic Info

    Paper provided by Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP) in its series Discussion Papers in Economics and Business with number 11-29.

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    Length: 24 pages
    Date of creation: Nov 2011
    Date of revision:
    Handle: RePEc:osk:wpaper:1129

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    Web page: http://www.econ.osaka-u.ac.jp/
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    Related research

    Keywords: Real options; investment timing; costly external financing; growth option; optimal stopping.;

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    1. Steven M. Fazzari & R. Glenn Hubbard & BRUCE C. PETERSEN, 1988. "Financing Constraints and Corporate Investment," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(1), pages 141-206.
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    10. Glenn W. Boyle & Graeme A. Guthrie, 2003. "Investment, Uncertainty, and Liquidity," Journal of Finance, American Finance Association, vol. 58(5), pages 2143-2166, October.
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    14. Myers, Stewart C, 1984. " The Capital Structure Puzzle," Journal of Finance, American Finance Association, vol. 39(3), pages 575-92, July.
    15. Shibata, Takashi & Nishihara, Michi, 2012. "Investment timing under debt issuance constraint," Journal of Banking & Finance, Elsevier, vol. 36(4), pages 981-991.
    16. Suresh Sundaresan & Neng Wang, 2007. "Investment under Uncertainty with Strategic Debt Service," American Economic Review, American Economic Association, vol. 97(2), pages 256-261, May.
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    Cited by:
    1. 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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