The Value of Financial Flexibility




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    • Gamba is at the SAFE (Studies in Applied Financial Economics) Center, Department of Economics, University of  Verona, Italy. Triantis is at the Robert H. Smith School of Business, University of Maryland. We thank Lorenzo Garlappi (Western Finance Association discussant), Ilya Strebulaev (American Finance Association discussant), Yuri Tserlukevich (European Finance Association discussant), and an anonymous referee for their very helpful comments. The authors gratefully acknowledge financial support from MURST (Ministero dell'Universit e della Ricerca Scientifica e Tecnologica), the Robert H. Smith School of Business, and the University of Maryland Graduate Research Board.


We develop a model that endogenizes dynamic financing, investment, and cash retention/payout policies in order to analyze the effect of financial flexibility on firm value. We show that the value of financing flexibility depends on the costs of external financing, the level of corporate and personal tax rates that determine the effective cost of holding cash, the firm's growth potential and maturity, and the reversibility of capital. Through simulations, we demonstrate that firms facing financing frictions should simultaneously borrow and lend, and we examine the nature of dynamic debt and liquidity policies and the value associated with corporate liquidity.