We thank the editor, two anonymous referees, Richard Friberg, Chris Hennessy, Mitri Kitti, Thomas Mariotti, Niku Määttänen, Juuso Välimäki, Johan Walden, and numerous seminar audiences for helpful comments and Jia Yu for excellent research assistance. Murto thanks the Academy of Finland and Terviö thanks the OpenLink Fund at the Coleman Fung Risk Management Research Center at UC Berkeley and the European Research Council (ERC Grant Agreement no. 240970) for financial support.
EXIT OPTIONS AND DIVIDEND POLICY UNDER LIQUIDITY CONSTRAINTS
Article first published online: 22 JAN 2014
© (2014) by the Economics Department of the University of Pennsylvania and the Osaka University Institute of Social and Economic Research Association
International Economic Review
Volume 55, Issue 1, pages 197–221, February 2014
How to Cite
MURTO, P. and TERVIÖ, M. (2014), EXIT OPTIONS AND DIVIDEND POLICY UNDER LIQUIDITY CONSTRAINTS. International Economic Review, 55: 197–221. doi: 10.1111/iere.12046
- Issue published online: 22 JAN 2014
- Article first published online: 22 JAN 2014
- Manuscript Revised: OCT 2012
- Manuscript Received: JAN 2012
- Academy of Finland
- OpenLink Fund at the Coleman Fung Risk Management Research Center at UC Berkeley
- European Research Council (ERC). Grant Number: 240970
We introduce a post-entry liquidity constraint to the standard model of a firm with serially correlated profitability and an irreversible exit decision. We assume that firms with no cash holdings and negative cash flow must either exit or raise new cash at a transaction cost. This creates a precautionary motive for holding cash, which must be traded off against the liquidity cost of holding cash. We characterize the optimal exit and payout policy. The direct effect of financial frictions is to impose inefficient exit, but there is also an indirect effect through higher equilibrium price that leads to inefficient survival.