On the Role of External Financing Costs in Optimal Investment Decisions

Mohamed Belhaj () and Nataliya Klimenko ()
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Nataliya Klimenko: Centrale Marseille (Aix-Marseille School of Economics), CNRS & EHESS.

No 1241, AMSE Working Papers from Aix-Marseille School of Economics, France

Abstract: This paper brings into focus a link between the investment and financing decisions of a firm which has an access to costly debt financing. Our analysis shows that lump-sum debt issuance costs play a prominent role in a determination of the optimal investment strategy. Faced with larger lump-sum debt issuance costs, a firm will optimally set up a higher-scale investment project in order to "compensate" dead-weight financing costs by higher return. Moreover, in the presence of lump-sum debt issuance costs, the optimal investment scale of financially constrained firms exhibits an inverted U-shaped relationship with the firm's borrowing capacity, so that relatively more/less constrained firms will realize smaller investment projects, whereas firms with an intermediate borrowing capacity will undertake larger investment.

Keywords: Real options; investment intensity; debt issuance costs; credit constraints. (search for similar items in EconPapers)
JEL-codes: G31 G32 G33 (search for similar items in EconPapers)
Pages: 17 pages
Date: 2012-12
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Working Paper: On the Role of External Financing Costs in Optimal Investment Decisions (2012)
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Persistent link: https://EconPapers.repec.org/RePEc:aim:wpaimx:1241

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