Capital Supply Uncertainty, Cash Holdings, and Investment

Abstract

We develop a dynamic model of investment, financing, and cash management decisions in which investment is lumpy and firms face capital supply uncertainty. We characterize optimal policies explicitly, demonstrate that smooth-pasting conditions may not guarantee optimality, and show that firms may not follow standard Miller and Orr (1966) barrier policies. In the model, firms with high investment costs differ in their behaviors from firms with low investment costs, financing policy does not follow a strict pecking order, and the optimal payout policy may feature several regions with both incremental and lumpy dividend payments.

Keywords: Capital supply uncertainty, cash management, lumpy investment, inventory models

JEL Classification: D83, G24, G31, G33, G35