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Optimal investment with fixed refinancing costs

  • Jason G. Cummins
  • Ingmar Nyman

Case studies show that corporate managers seek financial independence to avoid interference by outside financiers. We incorporate this financial xenophobia as a fixed cost in a simple dynamic model of financing and investment. To avoid refinancing in the future, the firm alters its behavior depending on the extent of its financial xenophobia and the realization of a revenue shock. With a sufficiently adverse shock, the firm holds no liquidity. Otherwise, the firm precautionarily saves and holds both liquidity and external finance. Investment always responds to neoclassical fundamentals, but responds to cash flow only when the firm holds no liquidity.

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Paper provided by Board of Governors of the Federal Reserve System (U.S.) in its series Finance and Economics Discussion Series with number 2001-40.

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Date of creation: 2001
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Handle: RePEc:fip:fedgfe:2001-40
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