Corporate Financial and Investment Policies when Future Financing is Not Frictionless

37 Pages Posted: 15 Nov 2006 Last revised: 27 Sep 2010

Heitor Almeida

University of Illinois at Urbana-Champaign; National Bureau of Economic Research (NBER)

Murillo Campello

Cornell University; National Bureau of Economic Research (NBER)

Michael S. Weisbach

Ohio State University (OSU) - Department of Finance; National Bureau of Economic Research (NBER)

Multiple version iconThere are 2 versions of this paper

Date Written: September 17, 2008

Abstract

We study a model in which future financing constraints leas firms to have a preference for investments with sorter payback periods, investments with less risk, and investments that utilize more pledgeable assets. The model also shows how investment distortions towards more liquid, safer assets vary with the marginal cost of external financing and with firm internal cash flows. Our theory helps reconcile and interpret a number of patterns reported in the empirical literature, in areas such as risk-taking behavior, capital structure choices, hedging strategies, and cash management policies. For example, contrary to Jensen and Meckling (1976), we show that firms may reduce rather than increase risk when leverage increases exogenously. Furthermore, firms in economies with less developed financial markets will not only take different quantities of investment, but will also take different kinds of investment (safer, short-term projects that are potentially less profitable). We also point out to several predictions that have not been empirically examined. For example, our model predicts that investment safety and liquidity are complementary: constrained firms are specially likely to decrease the risk of their most liquid investments.

Keywords: financial constraints, types of investment, capital budgeting, risk shifting

JEL Classification: D90, G31, G32, M40, M41, M46

Suggested Citation

Almeida, Heitor and Campello, Murillo and Weisbach, Michael S., Corporate Financial and Investment Policies when Future Financing is Not Frictionless (September 17, 2008). Charles A. Dice Center Working Paper No. 2008-16 and Fisher College of Business Working Paper No. 2008-03-015. Available at SSRN: https://ssrn.com/abstract=944914 or http://dx.doi.org/10.2139/ssrn.944914

Heitor Almeida

University of Illinois at Urbana-Champaign ( email )

515 East Gregory Drive
4037 BIF
Champaign, IL 61820
United States
217-3332704 (Phone)

HOME PAGE: http://www.business.illinois.edu/FacultyProfile/faculty_profile.aspx?ID=11357

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

Murillo Campello

Cornell University ( email )

114 East Avenue
369 Sage Hall
Ithaca, NY 14853
United States

HOME PAGE: http://www.johnson.cornell.edu/Faculty-And-Research/Profile.aspx?id=mnc35

National Bureau of Economic Research (NBER) ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138

Michael S. Weisbach (Contact Author)

Ohio State University (OSU) - Department of Finance ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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