NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH
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Investment under Uncertainty with Financial Constraints

Patrick Bolton, Neng Wang, Jinqiang Yang

NBER Working Paper No. 20610
Issued in October 2014, Revised in July 2019
NBER Program(s):The Asset Pricing Program, The Corporate Finance Program, The Economic Fluctuations and Growth Program

We develop an integrated theory of investment, seasoned equity offerings (SEOs), liquidation, and corporate savings under uncertainty for a financially constrained firm, which features endogenous growth options, abandonment options, and payout policies. Facing costly external financing, the firm prefers to fund its investment internally, so that its optimal policies and value depend on both its earnings fundamentals and liquidity holdings. The firm values not only real flexibility but also financial flexibility. The interaction of real and financial flexibility generates novel real options results: (1) Limited financial slack significantly erodes the value of growth & abandonment options; (2) Firms prefer projects with front-loaded cash-flows; (3) The firm's incentive to forgo costly external financing and to accumulate internal funds may cause substantial delay in investment; (4) A financially constrained firm over-invests in early stages of its life-cycle in an effort to quickly build up its cash-flow generating capacity; (5) SEOs are driven by both firm survival and growth motives. A firm in the mature phase may find itself in three mutually exclusive regions: payout, inaction, and liquidation. A firm in its growth phase may find itself in two additional regions: a region where investment is partly financed with an SEO and a region where investment is solely financed with internal funds. These regions depend on both firm savings and earnings fundamentals.

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Document Object Identifier (DOI): 10.3386/w20610

Published: Patrick Bolton & Neng Wang & Jinqiang Yang, 2019. "Investment under uncertainty with financial constraints," Journal of Economic Theory, .

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