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Department of Business Studies, Aarhus School of Business, University of Aarhus Finance Research Group Working Papers, Department of Business Studies, Aarhus School of Business, University of Aarhus

No F-2009-04:
Investment Timing, Liquidity, and Agency Costs of Debt

Stefan Hirth () and Marliese Uhrig-Homburg

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

Keywords: investment timing; liquidity; agency costs of debt; capital structure; real options; (follow links to similar papers)

48 pages, May 5, 2009

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