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Investment timing with fixed and proportional costs of external financing

  • Michi Nishihara


    (Graduate School of Economics, Osaka University)

  • Takashi Sshibata


    (Graduate School of Social Sciences, Tokyo Metropolitan University)

We develop a dynamic model in which a firm exercises an option to expand production with cash balance and costly external funds. While related papers explain their results only by numerical examples, we analytically prove the following results. In the presence of only a proportional cost of external financing, the firm with more cash balance invests earlier; however, the presence of both proportional and fixed costs leads to a non-monotonic relation between the investment time and cash balance. The firm with more cash balance invests later to save a fixed cost, particularly when the cash balance is close to the investment cost. Our results can potentially account for a variety of empirical results concerning the relation between investment volume and financing constraints.

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Paper provided by Osaka University, Graduate School of Economics and Osaka School of International Public Policy (OSIPP) in its series Discussion Papers in Economics and Business with number 11-29.

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Length: 24 pages
Date of creation: Nov 2011
Date of revision:
Handle: RePEc:osk:wpaper:1129
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  1. Altinkilic, Oya & Hansen, Robert S, 2000. "Are There Economies of Scale in Underwriting Fees? Evidence of Rising External Financing Costs," Review of Financial Studies, Society for Financial Studies, vol. 13(1), pages 191-218.
  2. Hirth, Stefan & Uhrig-Homburg, Marliese, 2009. "Investment Timing, Liquidity, and Agency Costs of Debt," Finance Research Group Working Papers F-2009-04, University of Aarhus, Aarhus School of Business, Department of Business Studies.
  3. Sean Cleary & Paul Povel & Michael Raith, 2003. "The U-shaped Investment Curve: Theory and Evidence," Finance 0311010, EconWPA.
  4. Svetlana Boyarchenko, 2004. "Irreversible Decisions and Record-Setting News Principles," American Economic Review, American Economic Association, vol. 94(3), pages 557-568, June.
  5. Stewart C. Myers, 1984. "Capital Structure Puzzle," NBER Working Papers 1393, National Bureau of Economic Research, Inc.
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  7. Michi Nishihara & Takashi Shibata, 2010. "Interactions between Preemptive Competition and a Financing Constraint," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 19(4), pages 1013-1042, December.
  8. Milne, Alistair & Robertson, Donald, 1996. "Firm behaviour under the threat of liquidation," Journal of Economic Dynamics and Control, Elsevier, vol. 20(8), pages 1427-1449, August.
  9. Shibata, Takashi & Nishihara, Michi, 2012. "Investment timing under debt issuance constraint," Journal of Banking & Finance, Elsevier, vol. 36(4), pages 981-991.
  10. Takeo Hoshi & Anil K. Kashyap & David Scharfstein, 1989. "Corporate structure, liquidity, and investment: evidence from Japanese industrial groups," Finance and Economics Discussion Series 82, Board of Governors of the Federal Reserve System (U.S.).
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  12. Mark Broadie & Jér�me Detemple, 1997. "The Valuation of American Options on Multiple Assets," Mathematical Finance, Wiley Blackwell, vol. 7(3), pages 241-286.
  13. Shibata, Takashi & Nishihara, Michi, 2010. "Dynamic investment and capital structure under manager-shareholder conflict," Journal of Economic Dynamics and Control, Elsevier, vol. 34(2), pages 158-178, February.
  14. Myers, Stewart C., 1984. "Capital structure puzzle," Working papers 1548-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
  15. Ernesto Mordecki, 2002. "Optimal stopping and perpetual options for Lévy processes," Finance and Stochastics, Springer, vol. 6(4), pages 473-493.
  16. Joao F. Gomes, 2001. "Financing Investment," American Economic Review, American Economic Association, vol. 91(5), pages 1263-1285, December.
  17. 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.
  18. Suresh Sundaresan & Neng Wang, 2007. "Investment under Uncertainty with Strategic Debt Service," American Economic Review, American Economic Association, vol. 97(2), pages 256-261, May.
  19. Christopher A. Hennessy & Toni M. Whited, 2005. "Debt Dynamics," Journal of Finance, American Finance Association, vol. 60(3), pages 1129-1165, 06.
  20. Glenn W. Boyle & Graeme A. Guthrie, 2003. "Investment, Uncertainty, and Liquidity," Journal of Finance, American Finance Association, vol. 58(5), pages 2143-2166, October.
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