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Investment timing and cash management with time-inconsistent preferences

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  • Liu, Miao
  • Luo, Pengfei

Abstract

We develop a dynamic model of investment timing and liquidity management for a financially constrained all-equity firm whose entrepreneur has time-inconsistent preferences. We provide closed-form solutions for the equity value before and after investment and for the optimal investment threshold. We find that entrepreneur’s time inconsistency delays investment and increases the firm’s cash holdings for investment, which provides a potential theoretical explanation for why firms hold substantial cash. In addition, the investment financing mix violates the pecking order when the degree of time inconsistency is low: firms issue external equity even when internal funds are available. When the degree of time inconsistency is high, investment is financed entirely with internal cash, which aligns with the predictions of the pecking order.

Suggested Citation

  • Liu, Miao & Luo, Pengfei, 2026. "Investment timing and cash management with time-inconsistent preferences," Economics Letters, Elsevier, vol. 267(C).
    • Handle: RePEc:eee:ecolet:v:267:y:2026:i:c:s0165176526002624
    DOI: 10.1016/j.econlet.2026.113068
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    JEL classification:

    • D81 - Microeconomics - - Information, Knowledge, and Uncertainty - - - Criteria for Decision-Making under Risk and Uncertainty
    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies

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