IDEAS home Printed from https://ideas.repec.org/a/eee/ecmode/v152y2025ics0264999325002275.html

Optimal investment and financing with government subsidies under time to build

Author

Listed:
  • Xia, Xin
  • Hu, Shaoyong
  • Gan, Liu

Abstract

This paper develops a real-options model that incorporates the game-theoretic interaction between firms and the government. We examine how government subsidies influence a firm’s optimal investment and financing decisions when accounting for time-to-build delays. Our findings indicate that subsidies induce leveraged firms to accelerate investment, albeit with a smaller investment scale and more conservative debt financing. Additionally, despite receiving fewer subsidies, leveraged firms tend to invest both earlier and at a larger scale than unleveraged firms. Furthermore, as subsidies become more effective at reducing time to build, investment is accelerated, leverage declines, and the optimal investment scale exhibits a U-shaped pattern. Lastly, compared to non-negotiated debt, the effect of negotiated-debt financing on optimal subsidies and investment scale depends on shareholders’ bargaining power. Our model offers novel and practical insights for policymakers designing effective subsidy programs and for managers formulating sound business strategies.

Suggested Citation

  • Xia, Xin & Hu, Shaoyong & Gan, Liu, 2025. "Optimal investment and financing with government subsidies under time to build," Economic Modelling, Elsevier, vol. 152(C).
    • Handle: RePEc:eee:ecmode:v:152:y:2025:i:c:s0264999325002275
    DOI: 10.1016/j.econmod.2025.107232
    as

    Download full text from publisher

    File URL: http://www.sciencedirect.com/science/article/pii/S0264999325002275
    Download Restriction: Full text for ScienceDirect subscribers only
    File URL: https://libkey.io/10.1016/j.econmod.2025.107232?utm_source=ideas
    LibKey link: if access is restricted and if your library uses this service, LibKey will redirect you to where you can use your library subscription to access this item
    ---><---

    As the access to this document is restricted, you may want to

    for a different version of it.

    References listed on IDEAS

    as
    1. Dirk Hackbarth & David C. Mauer, 2012. "Optimal Priority Structure, Capital Structure, and Investment," The Review of Financial Studies, Society for Financial Studies, vol. 25(3), pages 747-796.
    2. Jeon, Haejun, 2021. "Investment and financing decisions in the presence of time-to-build," European Journal of Operational Research, Elsevier, vol. 288(3), pages 1068-1084.
    3. Danielova, Anna & Sarkar, Sudipto, 2011. "The effect of leverage on the tax-cut versus investment-subsidy argument," Review of Financial Economics, Elsevier, vol. 20(4), pages 123-129.
    4. Gan, Liu & Xia, Xin & Chen, Yifei, 2018. "Investment and financing choices by time-inconsistent managers," The North American Journal of Economics and Finance, Elsevier, vol. 46(C), pages 29-48.
    5. Alvarez, Luis H. R. & Keppo, Jussi, 2002. "The impact of delivery lags on irreversible investment under uncertainty," European Journal of Operational Research, Elsevier, vol. 136(1), pages 173-180, January.
    6. Huamao Wang & Qing Xu & Jinqiang Yang, 2018. "Investment timing and optimal capital structure under liquidity risk," The European Journal of Finance, Taylor & Francis Journals, vol. 24(11), pages 889-908, July.
    7. Dong, Linjia & Yang, Zhaojun, 2023. "Investment and financing analysis for a venture capital alternative," Economic Modelling, Elsevier, vol. 126(C).
    8. Giovanni Cerulli, 2010. "Modelling and Measuring the Effect of Public Subsidies on Business R&D: A Critical Review of the Econometric Literature," The Economic Record, The Economic Society of Australia, vol. 86(274), pages 421-449, September.
    9. Shibata, Takashi & Nishihara, Michi, 2023. "Optimal financing and investment strategies under asymmetric information on liquidation value," Journal of Banking & Finance, Elsevier, vol. 146(C).
    10. Tak-Yuen Wong & Jin Yu, 2022. "Credit Default Swaps and Debt Overhang," Management Science, INFORMS, vol. 68(3), pages 2069-2097, March.
    11. Leland, Hayne E, 1994. "Corporate Debt Value, Bond Covenants, and Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 49(4), pages 1213-1252, September.
    12. Tan, Yingxian & Luo, Pengfei, 2021. "The impact of debt restructuring on dynamic investment and financing policies," Economic Modelling, Elsevier, vol. 102(C).
    13. Shibata, Takashi & Nishihara, Michi, 2018. "Investment timing, reversibility, and financing constraints," Journal of Corporate Finance, Elsevier, vol. 48(C), pages 771-796.
    14. Majd, Saman & Pindyck, Robert S., 1987. "Time to build, option value, and investment decisions," Journal of Financial Economics, Elsevier, vol. 18(1), pages 7-27, March.
    15. Tsyplakov, Sergey, 2008. "Investment frictions and leverage dynamics," Journal of Financial Economics, Elsevier, vol. 89(3), pages 423-443, September.
    16. Bar-Ilan, Avner & Strange, William C., 1999. "The Timing and Intensity of Investment," Journal of Macroeconomics, Elsevier, vol. 21(1), pages 57-77, January.
    17. Gonçalo Pacheco-De-Almeida & Peter Zemsky, 2003. "The Effect of Time-to-Build on Strategic Investment under Uncertainty," Post-Print hal-00576375, HAL.
    18. Dirk Hackbarth & Dongming Sun, 2024. "Corporate Investment and Financing Dynamics," The Review of Corporate Finance Studies, Society for Financial Studies, vol. 13(3), pages 625-667.
    19. Erwan Morellec & Philip Valta & Alexei Zhdanov, 2015. "Financing Investment: The Choice Between Bonds and Bank Loans," Management Science, INFORMS, vol. 61(11), pages 2580-2602, November.
    20. Lukas, Elmar & Thiergart, Sascha, 2019. "The interaction of debt financing, cash grants and the optimal investment policy under uncertainty," European Journal of Operational Research, Elsevier, vol. 276(1), pages 284-299.
    21. Sarkar, Sudipto & Zhang, Chuanqian, 2015. "Investment policy with time-to-build," Journal of Banking & Finance, Elsevier, vol. 55(C), pages 142-156.
    22. Pacheco-de-Almeida, Goncalo & Zemsky, Peter, 2003. "The Effect of Time-to-Build on Strategic Investment under Uncertainty," RAND Journal of Economics, The RAND Corporation, vol. 34(1), pages 166-182, Spring.
    23. Liu, Xiang & Yang, Zhaojun, 2025. "Investments, credit guarantees, and government subsidies in a regime-switching framework," Macroeconomic Dynamics, Cambridge University Press, vol. 29, pages 1-1, January.
    24. Robert McDonald & Daniel Siegel, 1986. "The Value of Waiting to Invest," The Quarterly Journal of Economics, President and Fellows of Harvard College, vol. 101(4), pages 707-727.
    25. Mauer, David C. & Sarkar, Sudipto, 2005. "Real options, agency conflicts, and optimal capital structure," Journal of Banking & Finance, Elsevier, vol. 29(6), pages 1405-1428, June.
    26. Bar-Ilan, Avner & Strange, William C., 1998. "A model of sequential investment," Journal of Economic Dynamics and Control, Elsevier, vol. 22(3), pages 437-463, March.
    27. 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.
    28. Jeon, Haejun, 2021. "Investment timing and capacity decisions with time-to-build in a duopoly market," Journal of Economic Dynamics and Control, Elsevier, vol. 122(C).
    29. Zhaojun Yang, 2020. "Investment and asset securitization with an option‐for‐guarantee swap," European Financial Management, European Financial Management Association, vol. 26(4), pages 1006-1030, September.
    30. Suresh Sundaresan & Neng Wang & Jinqiang Yang, 2015. "Dynamic Investment, Capital Structure, and Debt Overhang," The Review of Corporate Finance Studies, Society for Financial Studies, vol. 4(1), pages 1-42.
    31. Shibata, Takashi & Nishihara, Michi, 2015. "Investment timing, debt structure, and financing constraints," European Journal of Operational Research, Elsevier, vol. 241(2), pages 513-526.
    32. Gan, Liu & Xia, Xin & Zhang, Hai, 2022. "Debt structure and debt overhang," Journal of Corporate Finance, Elsevier, vol. 74(C).
    33. Sarkar, Sudipto & Zhang, Chuanqian, 2020. "Investment and financing decisions with learning-curve technology," Journal of Banking & Finance, Elsevier, vol. 121(C).
    34. Kamoto, Shinsuke, 2023. "Investment decisions and financial leverage under a potential entry threat," Journal of Banking & Finance, Elsevier, vol. 154(C).
    35. Tuomas Takalo & Tanja Tanayama & Otto Toivanen, 2013. "Estimating the Benefits of Targeted R&D Subsidies," The Review of Economics and Statistics, MIT Press, vol. 95(1), pages 255-272, March.
    36. Barbosa, Luciana & Rodrigues, Artur & Sardinha, Alberto, 2022. "Optimal price subsidies under uncertainty," European Journal of Operational Research, Elsevier, vol. 303(1), pages 471-479.
    37. Morellec, Erwan & Schürhoff, Norman, 2011. "Corporate investment and financing under asymmetric information," Journal of Financial Economics, Elsevier, vol. 99(2), pages 262-288, February.
    38. Jeon, Haejun, 2024. "Time-to-build, regulation, and investment," European Journal of Operational Research, Elsevier, vol. 319(3), pages 999-1019.
    39. Shibata, Takashi & Nishihara, Michi, 2015. "Investment-based financing constraints and debt renegotiation," Journal of Banking & Finance, Elsevier, vol. 51(C), pages 79-92.
    40. Dirk Hackbarth & Christopher A. Hennessy & Hayne E. Leland, 2007. "Can the Trade-off Theory Explain Debt Structure?," The Review of Financial Studies, Society for Financial Studies, vol. 20(5), pages 1389-1428, 2007 04.
    41. Sarkar, Sudipto, 2011. "Optimal size, optimal timing and optimal financing of an investment," Journal of Macroeconomics, Elsevier, vol. 33(4), pages 681-689.
    42. Fan, Hua & Sundaresan, Suresh M, 2000. "Debt Valuation, Renegotiation, and Optimal Dividend Policy," The Review of Financial Studies, Society for Financial Studies, vol. 13(4), pages 1057-1099.
    43. Glover, Brent, 2016. "The expected cost of default," Journal of Financial Economics, Elsevier, vol. 119(2), pages 284-299.
    44. Della Seta, Marco & Gryglewicz, Sebastian & Kort, Peter M., 2012. "Optimal investment in learning-curve technologies," Journal of Economic Dynamics and Control, Elsevier, vol. 36(10), pages 1462-1476.
    45. Azevedo, Alcino & Pereira, Paulo J. & Rodrigues, Artur, 2021. "Optimal timing and capacity choice with taxes and subsidies under uncertainty," Omega, Elsevier, vol. 102(C).
    Full references (including those not matched with items on IDEAS)

    Most related items

    These are the items that most often cite the same works as this one and are cited by the same works as this one.
    1. Gan, Liu & Xia, Xin & Zhang, Hai, 2022. "Debt structure and debt overhang," Journal of Corporate Finance, Elsevier, vol. 74(C).
    2. Haejun Jeon, 2023. "Time-to-build and capacity expansion," Annals of Operations Research, Springer, vol. 328(2), pages 1461-1494, September.
    3. Gan, Liu & Xia, Xin & Chen, Yifei, 2018. "Investment and financing choices by time-inconsistent managers," The North American Journal of Economics and Finance, Elsevier, vol. 46(C), pages 29-48.
    4. Lukas, Elmar & Thiergart, Sascha, 2019. "The interaction of debt financing, cash grants and the optimal investment policy under uncertainty," European Journal of Operational Research, Elsevier, vol. 276(1), pages 284-299.
    5. Jeon, Haejun, 2024. "The effects of time-to-build and regulation on investment timing and size," International Review of Financial Analysis, Elsevier, vol. 96(PB).
    6. Nishihara, Michi & Shibata, Takashi, 2025. "Optimal capital structure with earnings above a floor," European Journal of Operational Research, Elsevier, vol. 326(3), pages 656-673.
    7. Nishihara, Michi & Shibata, Takashi, 2016. "Asset sale, debt restructuring, and liquidation," Journal of Economic Dynamics and Control, Elsevier, vol. 67(C), pages 73-92.
    8. Nishihara, Michi & Shibata, Takashi & Zhang, Chuanqian, 2023. "Corporate investment, financing, and exit model with an earnings-based borrowing constraint," International Review of Financial Analysis, Elsevier, vol. 85(C).
    9. Jeon, Haejun, 2024. "Time-to-build, regulation, and investment," European Journal of Operational Research, Elsevier, vol. 319(3), pages 999-1019.
    10. Nishihara, Michi & Shibata, Takashi, 2019. "Liquidation, fire sales, and acquirers’ private information," Journal of Economic Dynamics and Control, Elsevier, vol. 108(C).
    11. Shibata, Takashi & Nishihara, Michi, 2018. "Investment timing, reversibility, and financing constraints," Journal of Corporate Finance, Elsevier, vol. 48(C), pages 771-796.
    12. Strebulaev, Ilya A. & Whited, Toni M., 2012. "Dynamic Models and Structural Estimation in Corporate Finance," Foundations and Trends(R) in Finance, now publishers, vol. 6(1–2), pages 1-163, November.
    13. Erwan Morellec & Philip Valta & Alexei Zhdanov, 2015. "Financing Investment: The Choice Between Bonds and Bank Loans," Management Science, INFORMS, vol. 61(11), pages 2580-2602, November.
    14. Jeon, Haejun, 2021. "Investment timing and capacity decisions with time-to-build in a duopoly market," Journal of Economic Dynamics and Control, Elsevier, vol. 122(C).
    15. Lotfaliei, Babak, 2018. "Zero leverage and the value in waiting to have debt," Journal of Banking & Finance, Elsevier, vol. 97(C), pages 335-349.
    16. Jeon, Haejun, 2021. "Investment and financing decisions in the presence of time-to-build," European Journal of Operational Research, Elsevier, vol. 288(3), pages 1068-1084.
    17. Rodrigues, Artur, 2025. "Investment and leverage decisions under caps and floors," International Review of Financial Analysis, Elsevier, vol. 97(C).
    18. Tan, Yingxian & Luo, Pengfei, 2021. "The impact of debt restructuring on dynamic investment and financing policies," Economic Modelling, Elsevier, vol. 102(C).
    19. Fredrik Armerin & Han-Suck Song, 2021. "A framework for modelling cash flow lags," SN Business & Economics, Springer, vol. 1(10), pages 1-13, October.
    20. Liu, Bo & Xia, Xin & Yang, Jinqiang, 2017. "Financing constraints and the use of performance-sensitive debt," The North American Journal of Economics and Finance, Elsevier, vol. 40(C), pages 73-84.

    More about this item

    Keywords

    ;
    ;
    ;
    ;

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • 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

    Statistics

    Access and download statistics

    Corrections

    All material on this site has been provided by the respective publishers and authors. You can help correct errors and omissions. When requesting a correction, please mention this item's handle: RePEc:eee:ecmode:v:152:y:2025:i:c:s0264999325002275. See general information about how to correct material in RePEc.

    If you have authored this item and are not yet registered with RePEc, we encourage you to do it here. This allows to link your profile to this item. It also allows you to accept potential citations to this item that we are uncertain about.

    If CitEc recognized a bibliographic reference but did not link an item in RePEc to it, you can help with this form .

    If you know of missing items citing this one, you can help us creating those links by adding the relevant references in the same way as above, for each refering item. If you are a registered author of this item, you may also want to check the "citations" tab in your RePEc Author Service profile, as there may be some citations waiting for confirmation.

    For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: Catherine Liu (email available below). General contact details of provider: http://www.elsevier.com/locate/inca/30411 .

    Please note that corrections may take a couple of weeks to filter through the various RePEc services.

    IDEAS is a RePEc service. RePEc uses bibliographic data supplied by the respective publishers.