Capital Supply Uncertainty, Cash Holdings, and Investment
Julien N. Hugonnier
Swiss Federal Institute of Technology Lausanne - Ecole Polytechnique Fédérale de Lausanne; Swiss Finance Institute
Ecole Polytechnique Federale de Lausanne and Swiss Finance Institute; Swiss Finance Institute
Swiss Finance Institute; Ecole Polytechnique Fédérale de Lausanne
May 22, 2013
Swiss Finance Institute Research Paper No. 11-44
We develop a model of investment, financing, and cash management decisions in which investment is lumpy and firms face uncertainty regarding their ability to raise funds in the capital markets. We characterize optimal policies explicitly and show that the smooth-pasting conditions used in prior contributions are necessary, but may not be sufficient, for an optimum. Instead of the standard Miller and Orr (1966) double-barrier policy for financing and payout, firms may optimally raise outside funds before exhausting internal resources and the optimal payout policy may feature several regions, with both smooth and discrete dividend payments. In the model, firms with high investment costs are qualitatively as well as quantitatively different in their investment, financing, and payout behaviors from firms with low investment costs. Finally, investment and payout do not always increase with slack, challenging the use of investment-cash flow sensitivities or payout ratios as measures of financing constraints.
Number of Pages in PDF File: 52
Keywords: Capital supply uncertainty, cash management, lumpy investment, inventory models
JEL Classification: D83, G24, G31, G33, G35working papers series
Date posted: August 15, 2010 ; Last revised: May 22, 2013
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