Firm Behaviour Under the Threat of Liquidation: Implications for Output, Investment & Business Cycle Transmission

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Firm Behaviour Under the Threat of Liquidation: Implications for Output, Investment & Business Cycle Transmission

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Alistair Milne () (University of Surrey)
Donald Robertson

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Donald Robertson

Abstract

Cash balances of the firm follow a diffusion process, triggering liquidation when they cross a threshold value. Access to external funds is constrained. Shareholders are impatient. With these assumptions there is a precautionary motive for retaining earnings; the internal cost of funds and local risk-aversion are decreasing functions of net worth; and, in extensions of our basic model, output and investment are increasing functions of net worth. We numerically simulate aggregate behaviour of a population of such firms. Shocks to net worth lead to substantial and prolonged deviations from steady state, consistent with a financial mechanism of business cycle transmission.

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Paper provided by Department of Economics, University of Surrey in its series Department of Economics Discussion Papers with number 9402.

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Date of creation: Jan 1994
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Handle: RePEc:sur:surrec:9402

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Find related papers by JEL classification:
E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy

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Other versions:
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Other versions:
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