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On the Role of External Financing Costs in Optimal Investment Decisions

  • Mohamed Belhaj

    ()

    (Centrale Marseille (Aix-Marseille School of Economics), CNRS & EHESS)

  • Nataliya Klimenko

    ()

    (Centrale Marseille (Aix-Marseille School of Economics), CNRS & EHESS.)

This paper brings into focus a link between the investment and financing decisions of a firm which has an access to costly debt financing. Our analysis shows that lump-sum debt issuance costs play a prominent role in a determination of the optimal investment strategy. Faced with larger lump-sum debt issuance costs, a firm will optimally set up a higher-scale investment project in order to "compensate" dead-weight financing costs by higher return. Moreover, in the presence of lump-sum debt issuance costs, the optimal investment scale of financially constrained firms exhibits an inverted U-shaped relationship with the firm's borrowing capacity, so that relatively more/less constrained firms will realize smaller investment projects, whereas firms with an intermediate borrowing capacity will undertake larger investment.

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File URL: http://www.amse-aixmarseille.fr/sites/default/files/_dt/2012/wp_2012_-_nr_41.pdf
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Paper provided by Aix-Marseille School of Economics, Marseille, France in its series AMSE Working Papers with number 1241.

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Length: 17 pages
Date of creation: Dec 2012
Date of revision:
Handle: RePEc:aim:wpaimx:1241
Contact details of provider: Web page: http://www.amse-aixmarseille.fr/en

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  1. Alessandra Guariglia, . "Internal financial constraints, external financial constraints, and investment choice: Evidence from a panel of UK firms," Discussion Papers 07/03, University of Nottingham, Centre for Finance, Credit and Macroeconomics (CFCM).
  2. Sean Cleary & Paul Povel & Michael Raith, 2003. "The U-shaped Investment Curve: Theory and Evidence," Finance 0311010, EconWPA.
  3. Toni M. Whited, 1990. "Debt, liquidity constraints, and corporate investment: evidence from panel data," Finance and Economics Discussion Series 114, Board of Governors of the Federal Reserve System (U.S.).
  4. Kit Wong, 2010. "On the neutrality of debt in investment intensity," Annals of Finance, Springer, vol. 6(3), pages 335-356, July.
  5. Michi NISHIHARA & Takashi SHIBATA, 2012. "The effects of external financing costs on investment timing and sizing decisions," Discussion Papers in Economics and Business 12-07, Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP).
  6. Steven M. Fazzari & R. Glenn Hubbard & BRUCE C. PETERSEN, 1988. "Financing Constraints and Corporate Investment," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(1), pages 141-206.
  7. repec:adr:anecst:y:2009:i:93-94:p:11 is not listed on IDEAS
  8. Stefan Hirth & Marliese Uhrig-Homburg, 2010. "Investment Timing when External Financing is Costly," Journal of Business Finance & Accounting, Wiley Blackwell, vol. 37(7-8), pages 929-949.
  9. Sarkar, Sudipto, 2011. "Optimal size, optimal timing and optimal financing of an investment," Journal of Macroeconomics, Elsevier, vol. 33(4), pages 681-689.
  10. Lyandres, Evgeny, 2007. "Costly external financing, investment timing, and investment-cash flow sensitivity," Journal of Corporate Finance, Elsevier, vol. 13(5), pages 959-980, December.
  11. Steven N. Kaplan & Luigi Zingales, 1997. "Do Investment-Cash Flow Sensitivities Provide Useful Measures of Financing Constraints?," The Quarterly Journal of Economics, Oxford University Press, vol. 112(1), pages 169-215.
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