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Investment, Uncertainty, and Liquidity

Authors

  • Glenn W. Boyle,

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    • Boyle is at the University of Otago and Guthrie is at Victoria University of Wellington. For helpful comments, we are grateful to Louis Ederington, John Handley, Jayant Kale, Peter MacKay, John Powell, and seminar participants at Otago, Melbourne, and the 2002 New Zealand Finance Colloquium. Valuable suggestions from Rick Green (the editor) and an anonymous referee also significantly improved the paper, while Peter Grundy provided useful research assistance. Any remaining errors or ambiguities are our responsibility.

  • Graeme A. Guthrie

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    • Boyle is at the University of Otago and Guthrie is at Victoria University of Wellington. For helpful comments, we are grateful to Louis Ederington, John Handley, Jayant Kale, Peter MacKay, John Powell, and seminar participants at Otago, Melbourne, and the 2002 New Zealand Finance Colloquium. Valuable suggestions from Rick Green (the editor) and an anonymous referee also significantly improved the paper, while Peter Grundy provided useful research assistance. Any remaining errors or ambiguities are our responsibility.


Abstract

We analyze the dynamic investment decision of a firm subject to an endogenous financing constraint. The threat of future funding shortfalls lowers the value of the firm's timing options and encourages acceleration of investment beyond the first-best optimal level. As well as highlighting another way by which capital market frictions can distort investment behavior, this result implies that (1) the sensitivity of investment to cash flow can be greatest for high-liquidity firms and (2) greater uncertainty has an ambiguous effect on investment.

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