On the Interaction of Real and Financial Decisions of the Firm Under Uncertainty

This study analyzes the interaction between the optimal level of investment and debt financing. For this purpose, a model is structured in which a firm, facing an uncertain price, has to decide on its optimal level of investment and debt. The amount of investment sets a limit on output whose optimal level is determined after price is realized. The debt involved is risky (there exists a possibility of bankruptcy). The analysis proves that investment and its optimal financing have to be simultaneously determined and that a negative relationship exists between operating and financial leverage. We also demonstrate that as the tax rate increases, optimal capacity decreases and optimal leverage increases. An analysis of the impact of changes in the expected price shows that under some conditions, an increase in expected price would lead to an increase in optimal investment (firm size) and a decrease in optimal debt.     

The effect of leverage on the tax-cut versus investment-subsidy argument

Two common methods of attracting corporate investment are investment incentives and tax incentives. It is important to use the two incentives in the correct proportions, otherwise the government will give up too much value in the process of attracting investment. This paper examines the effect of tax cut and investment subsidy on the government's net benefit from a project. Earlier studies concluded that it was optimal to use only investment subsidy and no tax cuts. We show that this is not true when debt financing is possible, and it is generally optimal (from the government's perspective) to use a combination of tax reduction and investment subsidy. The optimal tax rate and optimal investment subsidy are identified and analyzed in the paper. It is shown that using a sub-optimal combination of incentives can result in substantial reduction of benefits for the government.     

INFLATION,INVESTMENT, AND DEBT

In this paper the effect of inflation on firms' investment and debt-financing decisions is examined. Inflation affects optimal investment and financing directly through the probability of accounting loss and the real value of depreciation and interest tax shields. In addition, when corporate and differential personal taxes cause investment and financing decisions to interact, inflation has indirect effects on these decisions through their interactions. In general, the overall effects of inflation on optimal investment and debt are ambiguous in sign. For tax-exempt firms, however, optimal investment and debt are independent of inflation. For firms that are always in a tax-paying position, higher inflation reduces optimal investment without affecting optimal debt. Furthermore, inflation causes total firm value to decrease if the depreciation rate exceeds the firm's debt/asset ratio.     

Debt overhang and non-distressed debt restructuring

In this paper, we analyse the restructuring of debt in the presence of debt overhang. The firm starts out with a debt liability and an investment opportunity. Then with unrestructured debt, the firm maintains the current borrowing payments until default or investment. If the creditors allow the parties to restructure the debt with exchange offers, then the borrowing payments change as well as the default and investment points. We find that there is a unique optimal restructuring path which maintains debt at positive levels but defers default indefinitely. This path is optimal regardless of whether the debt holders or the firm control the process through superior bargaining power. Moreover, a debt-for-equity exchange to remove all existing debt takes place just before investment that is followed by the issue of an optimal amount of new debt as part of the funding for the investment cost. The optimal investment trigger is higher along the optimal restructuring path than it is for an unlevered firm. We discuss the findings in the light of existing empirical evidence.     

Optimal Sequential Investment When Capital is Not Readily Reversible

When investment opportunities arrive one at a time and are reviewed sequentially, a corporation's optimal policy differs from a standard net present value rule if the corporation exercises control over an industry state variable and control is costly. The first condition presupposes a degree of market power for the firm; the second occurs if corporate investment decisions are imperfectly reversible. To address the problem of optimal investment in this context, a firm's investment decisions are modeled as a Markov reward process. The causes of economic irreversibility are discussed and general propositions concerning the optimal investment policy are derived. These propositions are then applied to the optimization of an exploration program by an oligopolistic firm (a price leader). Under particular demand and distributional assumptions, solutions for the optimal decision rule and the value of the exploration program are obtained and their properties examined.     

Minimizing the lifetime ruin under borrowing and short-selling constraints

In this paper, the optimal investment strategies for minimizing the probability of lifetime ruin under borrowing and short-selling constraints are found. The investment portfolio consists of multiple risky investments and a riskless investment. The investor withdraws money from the portfolio at a constant rate proportional to the portfolio value. In order to find the results, an auxiliary market is constructed, and the techniques of stochastic optimal control are used. Via this method, we show how the application of stochastic optimal control is possible for minimizing the probability of lifetime ruin problem defined under an auxiliary market.     

Robust portfolio choice with ambiguity and learning about return predictability

We analyze the optimal stock-bond portfolio under both learning and ambiguity aversion. Stock returns are predictable by an observable and an unobservable predictor, and the investor has to learn about the latter. Furthermore, the investor is ambiguity-averse and has a preference for investment strategies that are robust to model misspecifications. We derive a closed-form solution for the optimal robust investment strategy. We find that both learning and ambiguity aversion impact the level and structure of the optimal stock investment. Suboptimal strategies resulting either from not learning or from not considering ambiguity can lead to economically significant losses.     

Irreversible investment and discounting: an arbitrage pricing approach

This paper presents a unified approach to valuing investment projects under uncertainty, based on stochastic discount factors, by linking optimal stopping theory to the no-arbitrage principle in asset pricing. An investment threshold for the case where the discount factor and the project’s cash-flow both follow a geometric Brownian motion is derived. Comparative statics of the investment trigger are obtained adding to and clarifying on the uncertainty–investment debate. Finally, two different ways to obtain discount factors are illustrated: spanning assets and representative agent analysis. The link between the characteristics of these different approaches and the optimal investment policy is clarified.     

Agency and Optimal Investment Dynamics

Agency problems limit firms’ access to capital markets,curbing investment. Firms and investors seek contractual waysto mitigate these problems. What are the implications for investment?We present a theory of a firm’s investment dynamics inthe presence of agency problems and optimal long-term financialcontracts. We derive results relating firms’ investmentdecisions, current and past cash flows, firm size, capital structure,and dividends. Among the results, optimal investment is increasingin current and past cash flow; and optimal investment is positivelyserially correlated over time (after controlling for investmentopportunities). These results hold for a range of agency problems.(JEL G30, G31, G32, G35, D82, D86, D92)     

Conditions for rational investment short-termism

In this paper we examine the theoretical conditions under which a firm will have incentives to optimally choose investment projects of duration that deviates from its stated horizon objective. Our approach considers a context in which investment horizon is subject to randomness and its length is optimally chosen by each firm??s manager so that to maximize his/her objective function in the form of expected wage. Our framework derives the distribution of optimal horizon choices for which all managers would obtain the same level of expected wage. It is shown that the presence of asymmetric loss preferences in the form of higher costs from managers?? investment duration over-statements (under-statements), results in a shift of the distribution of optimal durations to the left (right), thus making investment short-termism (long-termism) more likely to appear. The degree of the shift and the shape of the distribution of optimal investment durations depend on the trade-offs between preference asymmetries and the shape of the data generating process.     

Intertemporal capital budgeting

This paper analyzes the optimal capital budgeting mechanism when divisional managers are privately informed about the arrival of future investment projects. Consistent with field study evidence, an optimal allocation mechanism can include a stipulation that a capital request for discretionary investment will be declined with positive probability in the period after a significant investment was made even though this is ex post suboptimal. The model derives a number of empirical predictions regarding capital budgeting and the investment of financially constrained firms.     

The Underinvestment and Overinvestment Hypotheses: an Analysis Using Panel Data

We study the relationship between firm value and investment to test the underinvestment and overinvestment hypotheses. The results obtained, using panel data methodology as the estimation method, indicate that the abovementioned relation is quadratic, which implies that there exists an optimal level of investment. As a consequence, firms that invest less than the optimal level suffer from an underinvestment problem, while those investing more than the optimum suffer from overinvestment. The quadratic relation is maintained when firms are classified depending on their investment opportunities, the optimum being in accordance with the quality of investment opportunities.     

Least-squares Monte-Carlo methods for optimal stopping investment under CEV models

The optimal stopping investment is a kind of mixed expected utility maximization problems with optimal stopping time. The aim of this paper is to develop the least-squares Monte-Carlo methods to solve the optimal stopping investment under the constant elasticity of variance (CEV) model. Such a problem has no closed-form solutions for the value functions, optimal strategies and optimal exercise boundaries due to the early exercised feature. The dual optimal stopping problem is first derived and then the strong duality between the dual and prime problems is established. The least-squares Monte-Carlo methods based on the dual control theory are developed and numerical simulations are provided. Both the power and non-HARA utilities are studied.     

Asymptotic Investment Behaviors under a Jump-Diffusion Risk Process

We study an optimal investment control problem for an insurance company. The surplus process follows the Cramer-Lundberg process with perturbation of a Brownian motion. The company can invest its surplus into a risk-free asset and a Black-Scholes risky asset. The optimization objective is to minimize the probability of ruin. We show by new operators that the minimal ruin probability function is a classical solution to the corresponding HJB equation. Asymptotic behaviors of the optimal investment control policy and the minimal ruin probability function are studied for low surplus levels with a general claim size distribution. Some new asymptotic results for large surplus levels in the case with exponential claim distributions are obtained. We consider two cases of investment control: unconstrained investment and investment with a limited amount.     

基于随机微分博弈的保险公司最优决策模型

本文研究了基于保险公司与自然之间二人-零和随机微分博弈的最优投资及再保险问题。假设保险公司具有指数效用,自然是博弈的虚拟对手,通过求解最优控制问题对应的HJB I方程,得到了保险公司的最优投资和再保险策略以及最优值函数的闭式解。结果显示,在完全分保时(即自留比例为零),保险公司应该将全部财富购买无风险资产,即风险资产投资额为零;在不完全分保时保险公司将卖空风险资产,且卖空数量及保险自留比例都随保险公司盈余过程与风险资产间的相关性的提高而增大,随终止时刻T的临近而增加,但随市场中无风险资产回报率的增加而减少。     

Optimal dividend policy and growth option

We analyse the interaction between the dividend policy and the decision on investment in a growth opportunity of a liquidity constrained firm. This leads us to study a mixed singular control/optimal stopping problem for a diffusion that we solve quasi-explicitly by establishing a connection with an optimal stopping problem. We characterize situations where it is optimal to postpone the distribution of dividends in order to invest at a subsequent date in the growth opportunity. We show that uncertainty and liquidity shocks have an ambiguous effect on the investment decision.      

Bottlenecks in ramping up public investment

A windfall in a developing economy with capital scarcity and investment adjustment costs facing a temporary windfall should be used to give more consumption to poorer present generations and to speed up development by ramping up public investment and paying off debt taking due account of the increasing inefficiency as investment gets ramped up. The optimal strategy requires negative genuine saving; the permanent income requires zero genuine saving. The optimal real consumption increments are smaller once one allows for absorption constraints resulting from Dutch disease and sluggish adjustment of ‘home-grown’ public capital.     

我国上市公司投资:过度还是不足?——基于沪深工业类上市公司非效率投资的实证度量

本文提出了一个简洁、有效的企业非效率投资度量模型,并以沪深301家工业类上市公司为样本进行了实证度量。研究发现,2001—2006年间,样本公司最优投资率平均为年初固定资产净值的24.4%;但由于信息不对称和代理问题等的影响,39.26%的公司投资过度,实际投资平均水平超出其最优投资的100.66%;60.74%的公司投资不足,实际投资平均水平仅达到其最优投资的46.31%。     

On the neutrality of debt in investment intensity

This paper examines the interaction between investment and financing decisions of a firm using a real options approach. The firm is endowed with a perpetual option to invest in a project at any time by incurring an irreversible investment cost at that instant. The amount of the irreversible investment cost is directly related to the intensity of investment that is endogenously chosen by the firm. At the investment instant, the firm can finance the project by issuing debt and equity, albeit subject to an exogenously given credit constraint that prohibits the firm’s debt-to-asset ratio from exceeding a prespecified threshold. The optimal capital structure of the firm is determined by the trade-off between interest tax-shield benefits and bankruptcy costs of debt. Irrespective of whether the exogenously given credit constraint is binding or not, we show that leverage has no impact on the firm’s optimal investment intensity, thereby rendering the neutrality of debt in investment intensity. Similar to earlier work, we show that debt is not neutral to investment timing in general, and the levered firm invests earlier than the unlevered firm in particular.     

Overconfidence in investment decisions: An experimental approach

Abstract

By experimentally inducing risk aversion, overconfidence in an investment setting is investigated, comparing the evaluation of actual investment decisions with alternative choices. After selecting their own investment, subjects confront three alternative investment choices, including the optimal one, and are asked about their willingness to pay and to substitute their own for alternative choices. Overconfidence is defined as the persistent overevaluation of the own investment decision. Results indicate that overconfidence increases (i) with the absolute deviation from optimal choices, (ii) with task complexity involving the number of risky assets, and (iii) decreases with individual perceived uncertainty.