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Modeling the Effects of Financial Constraints on Firm´s Investment

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  • Tomat, Gian Maria

Abstract

The paper develops a model of firm´s investment under uncertainty with financial market imperfections and analyzes the effects of financial constraints on firm´s investment. Firm´s investment is an increasing function of the firm´s marginal q, however the investment function is characterized by an upper bound that depends on the firm´s borrowing capabilities. The firm´s marginal q is the sum of the expected value of the marginal profitability of the physical capital stock and of a positive external finance premium. In the presence of financial market imperfections the firm forms expectations about future financial conditions and these expectations raise the firm´s current marginal q. Similarly, the shadow price of firm´s debt is the sum of the interest cost of debt repayment and of a provision for external finance that depends on the firm´s expectations over future financial conditions.

Suggested Citation

  • Tomat, Gian Maria, 2007. "Modeling the Effects of Financial Constraints on Firm´s Investment," Economics Discussion Papers 2007-38, Kiel Institute for the World Economy (IfW).
  • Handle: RePEc:zbw:ifwedp:6165
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    More about this item

    Keywords

    firm´s investment; financial constraints; Tobin´s marginal q; uncertainty;

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • D92 - Microeconomics - - Micro-Based Behavioral Economics - - - Intertemporal Firm Choice, Investment, Capacity, and Financing

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