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Investment Timing, Liquidity, and Agency Costs of Debt

  • Hirth, Stefan

    ()

    (Department of Business Studies, Aarhus School of Business)

  • Uhrig-Homburg, Marliese

    (Chair of Financial Engineering and Derivatives)

This paper examines the effect of debt and liquidity on corporate investment in a continuous- time framework. We show that stockholder-bondholder agency conflicts cause investment thresholds to be U-shaped in leverage and decreasing in liquidity. In the absence of tax effects, we derive the optimal level of liquid funds that eliminates agency costs by implementing the first-best investment policy for a given capital structure. In a second step we generalize the framework by introducing a tax advantage of debt, and we show that an interior solution for liquidity and capital structure optimally trades off tax benefits and agency costs of debt

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Paper provided by University of Aarhus, Aarhus School of Business, Department of Business Studies in its series Finance Research Group Working Papers with number F-2009-04.

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Length: 48 pages
Date of creation: 05 May 2009
Date of revision:
Handle: RePEc:hhb:aarbfi:2009-04
Contact details of provider: Postal: The Aarhus School of Business, Fuglesangs Allé 4, DK-8210 Aarhus V, Denmark
Fax: + 45 86 15 19 43
Web page: http://www.asb.dk/about/departments/bs.aspx

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