Investment timing,liquidity, and agency costs of debt |
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| Authors: | Stefan Hirth Marliese Uhrig-Homburg |
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| Institution: | 1. Canada Research Chair in Risk Management, HEC Montreal, 3000, Chemin Cote-Sainte-Catherine, suite 4.454, Montreal, QC H3T 2A7, Canada;2. Department of Finance, University of Quebec in Montreal, C.P. 8888, succ. Centre-ville, Montreal, QC H3C 3P8, Canada;1. University of International Business and Economics, China;2. Beijing Foreign Studies University, China;3. Cardiff University, UK;4. Faculty of Business and Economics, University of Hong Kong, Hong Kong;1. Department of Economics, University of Birmingham, Birmingham B15 2TT, United Kingdom;2. Management School, University of Sheffield, Conduit Road, Sheffield S10 1FL, United Kingdom;1. World Bank, United States;2. Cheung Kong Graduate School of Business, China;3. Guanghua School of Management, Peking University, China;1. Department of Finance and Business Economics, Faculty of Business Administration, University of Macau, Macau, China;2. Department of Accounting, Finance and Economics, Griffith University, Gold Coast, QLD, Australia;3. Department of Accounting and Finance, College of Business and Economics, California State University, East Bay, Hayward, CA 94542, United States |
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| Abstract: | This paper examines the effect of debt and liquidity on corporate investment in a continuous-time framework. We show that stockholder–bondholder agency conflicts cause investment thresholds to be U-shaped in leverage and decreasing in liquidity. In the absence of tax effects, we derive the optimal level of liquid funds that eliminates agency costs by implementing the first-best investment policy for a given capital structure. In a second step we generalize the framework by introducing a tax advantage of debt, and we show that an interior solution for liquidity and capital structure optimally trades off tax benefits and agency costs of debt. |
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