Corporate Investment and Financing Dynamics

50 Pages Posted: 28 Aug 2015

See all articles by Dirk Hackbarth

Dirk Hackbarth

Boston University - Department of Finance & Economics; Centre for Economic Policy Research (CEPR); European Corporate Governance Institute (ECGI)

Dongming Sun

University of Illinois at Urbana-Champaign

Date Written: August 26, 2015

Abstract

This paper studies the behavior of leverage ratios in a dynamic trade-off model with real frictions. Firms underutilize debt when financing investment to retain financial flexibility. Underutilization of debt persists even when firms exercise their last investment options, and it is more (less) severe for more back-loaded (front-loaded) investment opportunities. Thus, leverage dynamics crucially hinge upon the structure of the investment process and otherwise identical firms appear to have significantly different target leverage ratios. Structural estimation of key parameters reveals that simulated model moments can match data moments. We obtain capital structure regression results in line with the empirical evidence, and explain the empirical puzzle that average leverage ratios are path-dependent and persistent for extended periods of time.

Keywords: Capital Structure, Corporate Investment, Financial Flexibility, Real Options

JEL Classification: G31, G32

Suggested Citation

Hackbarth, Dirk and Sun, Dongming, Corporate Investment and Financing Dynamics (August 26, 2015). Available at SSRN: https://ssrn.com/abstract=2651313 or http://dx.doi.org/10.2139/ssrn.2651313

Dirk Hackbarth (Contact Author)

Boston University - Department of Finance & Economics ( email )

Department of Finance
595 Commonwealth Avenue
Boston, MA 02215
United States
(617) 358-4206 (Phone)
(617) 353-6667 (Fax)

HOME PAGE: http://people.bu.edu/dhackbar/

Centre for Economic Policy Research (CEPR) ( email )

London
United Kingdom

European Corporate Governance Institute (ECGI) ( email )

c/o ECARES ULB CP 114
B-1050 Brussels
Belgium

Dongming Sun

University of Illinois at Urbana-Champaign ( email )

601 E John St
Champaign, IL 61820
United States

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