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The effects of external financing costs on investment timing and sizing decisions

Author

Listed:
  • Michi NISHIHARA

    (Graduate School of Economics, Osaka University)

  • Takashi SHIBATA

    (Graduate School of Social Sciences, Tokyo Metropolitan University)

Abstract
We develop a dynamic model in which a firm exercises an option to expand production on either a small or large scale with cash reserves and costly external funds. We show that the financing costs greatly distort the firm fs financing and investment behavior and result in a policy contingent on the dynamics of the cash flow and reserves. Most notably, we prove that an intermediate level of cash reserves is likely to accelerate investment in the small-scale project by interactions among financing costs, investment timing, and investment sizing. Our results fill the gap between two types of results: (i) empirical findings in a U-shaped relation between the investment volume and internal funds, and (ii) empirical predictions of a U-shaped relation between the investment timing and internal funds.

Suggested Citation

  • Michi NISHIHARA & Takashi SHIBATA, 2012. "The effects of external financing costs on investment timing and sizing decisions," Discussion Papers in Economics and Business 12-07, Osaka University, Graduate School of Economics.
    • Handle: RePEc:osk:wpaper:1207
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    Cited by:

    1. Ehab Yamani & David Rakowski, 2018. "Cash Flow and Discount Rate Risk in the Investment Effect: A Downside Risk Approach," Quarterly Journal of Finance (QJF), World Scientific Publishing Co. Pte. Ltd., vol. 8(03), pages 1-40, September.
    2. Mohamed Belhaj & Nataliya Klimenko, 2012. "On the Role of External Financing Costs in Optimal Investment Decisions," AMSE Working Papers 1241, Aix-Marseille School of Economics, France.
    3. Shibata, Takashi & Nishihara, Michi, 2015. "Investment timing, debt structure, and financing constraints," European Journal of Operational Research, Elsevier, vol. 241(2), pages 513-526.
    4. Ming, Zeng & Ximei, Liu & Yulong, Li & Lilin, Peng, 2014. "Review of renewable energy investment and financing in China: Status, mode, issues and countermeasures," Renewable and Sustainable Energy Reviews, Elsevier, vol. 31(C), pages 23-37.
    5. Michi Nishihara & Takashi Shibata, 2014. "Preemption, leverage, and financing constraints," Review of Financial Economics, John Wiley & Sons, vol. 23(2), pages 75-89, April.
    6. Di Corato, Luca & Moretto, Michele & Rossini, Gianpaolo, 2017. "Financing flexibility: The case of outsourcing," Journal of Economic Dynamics and Control, Elsevier, vol. 76(C), pages 35-65.
    7. Michi Nishihara, 2018. "Valuation of an R&D project with three types of uncertainty," EURO Journal on Decision Processes, Springer;EURO - The Association of European Operational Research Societies, vol. 6(1), pages 93-113, June.
    8. Shibata, Takashi & Nishihara, Michi, 2015. "Investment-based financing constraints and debt renegotiation," Journal of Banking & Finance, Elsevier, vol. 51(C), pages 79-92.
    9. Nishihara, Michi, 2014. "Preemptive investment game with alternative projects," Economic Modelling, Elsevier, vol. 43(C), pages 124-135.
    10. Michi Nishihara, 2017. "Valuation of an R&D project with three types of uncertainty," Discussion Papers in Economics and Business 17-15, Osaka University, Graduate School of Economics.
    11. Shobha Tewari & Bibek Bhattacharya, 2023. "Financial resources, corporate social responsibility, and ownership type: Evidence from India," Asia Pacific Journal of Management, Springer, vol. 40(3), pages 1093-1132, September.
    12. Michi Nishihara, 2014. "Valuation of sequential R&D investment under technological, market, and rival preemption uncertainty," Discussion Papers in Economics and Business 14-13, Osaka University, Graduate School of Economics.
    13. Takashi Shibata & Michi Nishihara, 2019. "Credit Spread And Liquidation Value-Based Debt Financing Constraint," International Journal of Theoretical and Applied Finance (IJTAF), World Scientific Publishing Co. Pte. Ltd., vol. 22(05), pages 1-27, August.

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    More about this item

    Keywords

    Investment timing; Investment size; Costly external financing; Optimal stopping;
    All these keywords.

    JEL classification:

    • G13 - Financial Economics - - General Financial Markets - - - Contingent Pricing; Futures Pricing
    • G31 - Financial Economics - - Corporate Finance and Governance - - - Capital Budgeting; Fixed Investment and Inventory Studies
    • G32 - Financial Economics - - Corporate Finance and Governance - - - Financing Policy; Financial Risk and Risk Management; Capital and Ownership Structure; Value of Firms; Goodwill

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