Firm Behaviour Under the Threat of Liquidation: Implications for Output, Investment & Business Cycle Transmission

Alistair Milne () and Donald Robertson

School of Economics Discussion Papers from School of Economics, University of Surrey

Abstract: Cash balances of the firm follow a diffusion process, triggering liquidation when they cross a threshold value. Access to external funds is constrained. Shareholders are impatient. With these assumptions there is a precautionary motive for retaining earnings; the internal cost of funds and local risk-aversion are decreasing functions of net worth; and, in extensions of our basic model, output and investment are increasing functions of net worth. We numerically simulate aggregate behaviour of a population of such firms. Shocks to net worth lead to substantial and prolonged deviations from steady state, consistent with a financial mechanism of business cycle transmission.

Keywords: Financing constraints; output; investment (search for similar items in EconPapers)
JEL-codes: E44 (search for similar items in EconPapers)
Date: 1994-01
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