IDEAS home Printed from https://ideas.repec.org/
MyIDEAS: Log in (now much improved!) to save this paper

Financing capacity investment under demand uncertainty

Listed author(s):
  • Francis de Véricourt

    (ESMT European School of Management and Technology)

  • Denis Gromb

    (INSEAD)

This paper studies the interplay between the operational and financial facets of capacity investment. We consider the capacity choice problem of a firm with limited liquidity and whose access to external capital markets is hampered by moral hazard. The firm must therefore not only calibrate its capacity investment and the corresponding funding needs, but also optimize its sourcing of funds. Importantly, the set of available sources of funds is derived endogenously and includes standard financial claims (debt, equity, etc.). We find that when higher demand realizations are more indicative of high effort, debt financing is optimal for any given capacity level. In this case, the optimal capacity is never below the efficient capacity level but sometimes strictly above that level. Further, the optimal capacity level increases with the moral hazard problem's severity and decreases with the firm's internal funds. This runs counter to the newsvendor logic and to the common intuition that by raising the cost of external capital and hence the unit capacity cost, financial market frictions should lower the optimal capacity level. We trace the value of increasing capacity beyond the efficient level to a bonus effect and a demand elicitation effect. Both stem from the risk of unmet demand, which is characteristic of capacity decisions under uncertainty.

If you experience problems downloading a file, check if you have the proper application to view it first. In case of further problems read the IDEAS help page. Note that these files are not on the IDEAS site. Please be patient as the files may be large.

File URL: http://static.esmt.org/publications/workingpapers/ESMT-14-03.pdf
File Function: First version, 2014
Download Restriction: no

Paper provided by ESMT European School of Management and Technology in its series ESMT Research Working Papers with number ESMT-14-03.

as
in new window

Length: 31 pages
Date of creation: 20 May 2014
Handle: RePEc:esm:wpaper:esmt-14-03
Contact details of provider: Postal:
Schlossplatz 1, 10178 Berlin

Phone: +49 (0)30 21231 0
Fax: +49 (0)30 21231 9
Web page: http://www.esmt.org
Email:


More information through EDIRC

References listed on IDEAS
Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:

as
in new window


  1. Onur Boyabatlı & L. Beril Toktay, 2011. "Stochastic Capacity Investment and Flexible vs. Dedicated Technology Choice in Imperfect Capital Markets," Management Science, INFORMS, vol. 57(12), pages 2163-2179, December.
  2. Joaquín Poblete & Daniel Spulber, 2012. "The form of incentive contracts: agency with moral hazard, risk neutrality, and limited liability," RAND Journal of Economics, RAND Corporation, vol. 43(2), pages 215-234, 06.
  3. Gromb, Denis & Martimort, David, 2007. "Collusion and the organization of delegated expertise," Journal of Economic Theory, Elsevier, vol. 137(1), pages 271-299, November.
  4. Innes, Robert D., 1990. "Limited liability and incentive contracting with ex-ante action choices," Journal of Economic Theory, Elsevier, vol. 52(1), pages 45-67, October.
  5. Tinglong Dai & Kinshuk Jerath, 2013. "Salesforce Compensation with Inventory Considerations," Management Science, INFORMS, vol. 59(11), pages 2490-2501, November.
  6. Jean Tirole, 2006. "The Theory of Corporate Finance," Post-Print hal-00173191, HAL.
  7. Lode Li & Martin Shubik & Matthew J. Sobel, 2013. "Control of Dividends, Capital Subscriptions, and Physical Inventories," Management Science, INFORMS, vol. 59(5), pages 1107-1124, May.
  8. Oyer, Paul, 2000. "A Theory of Sales Quotas with Limited Liability and Rent Sharing," Journal of Labor Economics, University of Chicago Press, vol. 18(3), pages 405-426, July.
Full references (including those not matched with items on IDEAS)

This item is not listed on Wikipedia, on a reading list or among the top items on IDEAS.

When requesting a correction, please mention this item's handle: RePEc:esm:wpaper:esmt-14-03. See general information about how to correct material in RePEc.

For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (ESMT Faculty Publications)

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 references are entirely missing, you can add them using this form.

If the full references list an item that is present in RePEc, but the system did not link 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 profile, as there may be some citations waiting for confirmation.

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

This information is provided to you by IDEAS at the Research Division of the Federal Reserve Bank of St. Louis using RePEc data.