The Cambridge Finance Seminar
Thursday 15th May
5-6pm
Bridgetower Room, Trinity Hall
Professor Wang Neng
Colombia University
Investment, Liquidity, and Financing under Uncertainty
We develop a real options model for a financially constrained firm. Facing external financing costs, the firm prefers to fund its investment through internal funds, so that the firm's optimal investment policy and its value depend on the size of its liquidity holdings. We show that financial constraints significantly alter the standard real options results. Importantly, the investment hurdle is highly non-monotonic in the firm's internal funds as the firm may prefer accumulating internal funds rather than accessing costly external capital markets when internal funds are sufficiently high. Additionally, the firm's external equity issue is non-monotonic in its liquidity holdings. With multiple rounds of growth options, a value-maximizing financially constrained firm may choose to exercise its growth option sooner that the first-best level in earlier stages in order to mitigate delayed growth option exercising in later stages. Our analysis brings out the rich and subtle interactions between sources of funds (external, internal, and endogenous retained earnings) and the optimal exercising of investment and abandonment options.
Refreshments will be provided.