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Learning about profitability and dynamic cash management

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  • Décamps, Jean-Paul
  • Villeneuve, Stéphane

Abstract

We study a dynamic model of a rm whose shareholders learn about its profitability, face costs of external nancing and costs of holding cash. The shareholders' problem involves a notoriously challenging singular stochastic control problem with a two-dimensional degenerate diffusion process. We solve it by means of an explicit construction of its value function, and derive a corporate life-cycle with two stages: a "probation stage" where it is never optimal for the firm to issue new shares, and a "mature stage" where the firm resorts to the market whenever needed. The cash target level is non-monotonic in the belief about the profitability and reaches its highest value on the edge between the two stages. It follows new insights on the firm's volatility and its payout ratio which depend on the firm's stage in its life cycle.

Suggested Citation

  • Décamps, Jean-Paul & Villeneuve, Stéphane, 2022. "Learning about profitability and dynamic cash management," TSE Working Papers 22-1301, Toulouse School of Economics (TSE).
    • Handle: RePEc:tse:wpaper:126577
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    More about this item

    Keywords

    Corporate cash management; Corporate life cycle; Learning; Singular control;
    All these keywords.

    JEL classification:

    • C02 - Mathematical and Quantitative Methods - - General - - - Mathematical Economics
    • C11 - Mathematical and Quantitative Methods - - Econometric and Statistical Methods and Methodology: General - - - Bayesian Analysis: General
    • C61 - Mathematical and Quantitative Methods - - Mathematical Methods; Programming Models; Mathematical and Simulation Modeling - - - Optimization Techniques; Programming Models; Dynamic Analysis
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill
    • G33 - Financial Economics - - Corporate Finance and Governance - - - Bankruptcy; Liquidation
    • G35 - Financial Economics - - Corporate Finance and Governance - - - Payout Policy

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