Investment timing, debt structure, and financing constraints

• Published in: European journal of operational research Vol. 241; no. 2; pp. 513 - 526
• Main Authors: Shibata, Takashi, Nishihara, Michi
• Format: Journal Article
• Language: English
• Published: Amsterdam Elsevier B.V 01.03.2015; Elsevier Sequoia S.A
• Subjects: Bond issues; Debt issuance limit constraints; Debt structure; Default; Finance; Investment policy; Investment strategies; Market timing; Operations research; Rates of return; Real options; Spread; Studies; Debt issuance limit constraints; Real options; Finance; Debt structure; Investment strategies
• ISSN: 0377-2217; 1872-6860
• DOI: 10.1016/j.ejor.2014.09.011

•We examine how debt issuance limits influence the structure of investment, financing, and debt.•An increase in debt issuance limits leads to a preference for the issue of market debt over bank debt.•Investment strategies are nonmonotonic with respect to debt issuance limits.•Debt issuance limits create distortions in the relationship between investment and value.•Debt issuance limits lead to debt holders experiencing low risk and low returns. We introduce debt issuance limit constraints along with market debt and bank debt to consider how financial frictions affect investment, financing, and debt structure strategies. Our model provides four important results. First, a firm is more likely to issue market debt than bank debt when its debt issuance limit increases. Second, investment strategies are nonmonotonic with respect to debt issuance limits. Third, debt issuance limits distort the relationship between a firm’s equity value and investment strategy. Finally, debt issuance limit constraints lead to debt holders experiencing low risk and low returns. That is, the more severe the debt issuance limits are, the lower are the credit spreads and default probabilities. Our theoretical results are consistent with stylized facts and empirical results.