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EXIT OPTIONS AND DIVIDEND POLICY UNDER LIQUIDITY CONSTRAINTS

Authors

  • PAULI MURTO,

    1. Aalto University School of Business and HECER, Finland
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  • MARKO TERVIÖ

    Corresponding author
    1. Aalto University School of Business and HECER, Finland
    • Please address correspondence to: Marko Terviö, Department of Economics, Aalto University, Arkadiankatu 7, Helsinki 00100, Finland. Phone: +358-40-353-8342. E-mail: marko.tervio@aalto.fi.

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    • 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.


Abstract

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.

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