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Investment timing, liquidity, and agency costs of debt

  • Hirth, Stefan
  • Uhrig-Homburg, Marliese

This paper examines the effect of debt and liquidity on corporate investment in a continuous-time framework. We show that stockholder-bondholder agency conflicts cause investment thresholds to be U-shaped in leverage and decreasing in liquidity. In the absence of tax effects, we derive the optimal level of liquid funds that eliminates agency costs by implementing the first-best investment policy for a given capital structure. In a second step we generalize the framework by introducing a tax advantage of debt, and we show that an interior solution for liquidity and capital structure optimally trades off tax benefits and agency costs of debt.

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File URL: http://www.sciencedirect.com/science/article/B6VFK-4Y6J3TB-1/2/79997151fe3bbf21d915dec0f007cf44
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Article provided by Elsevier in its journal Journal of Corporate Finance.

Volume (Year): 16 (2010)
Issue (Month): 2 (April)
Pages: 243-258

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Handle: RePEc:eee:corfin:v:16:y:2010:i:2:p:243-258
Contact details of provider: Web page: http://www.elsevier.com/locate/jcorpfin

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