The External Financing of Investment

Abstract

Investment characteristics and the form of external financing are linked. Factor analysis indicates that the principal determinant of the financing choice is whether an investment’s payoffs can be described as a hit or miss. Hit-or-miss investments are more likely to be equity financed. Equity also becomes more common the longer the time until an investment produces positive payoffs. Debt financing is more likely for investments that are both tangible and non-unique. For R&D-like investments, equity and bank debt financing are more likely than non-bank debt financing. Convertible securities link to uncertain investment lives and are therefore useful for sequential financing.

Keywords: Investment characteristics, financing, debt-equity choice, convertible securities

JEL Classification: E22, G32