Investment Timing When External Financing is Costly

Abstract:     
This paper analyzes the investment timing of firms facing two dimensions of financing constraints: Liquidity constraints and capital market frictions inducing financing costs. We show that liquidity constraints are not sufficient to explain voluntary investment delay. However, when additionally considering financing costs, we can explain both voluntary delay and acceleration of investment. More precisely, we find that investment thresholds are U-shaped in liquid funds. For high-liquidity firms, investment thresholds are decreasing (i.e. accelerated investment takes place) in either dimension of financing constraint. In contrast, investment thresholds are increasing (i.e. investment is further delayed) in either form of financing constraint for low-liquidity firms. For intermediate levels of liquidity, investment thresholds are U-shaped in market frictions.

Keywords: investment timing, underinvestment, overinvestment, real option valuation, costly external financing

JEL Classification: G31, G32

Accepted Paper Series