() and Marliese Uhrig-Homburg
Stefan Hirth: Department of Business Studies, Aarhus School of Business, Postal: The Aarhus School of Business, Fuglesangs Allé 4, 8210 Aarhus V, Denmark
Marliese Uhrig-Homburg: Chair of Financial Engineering and Derivatives, Postal: Universität Karlsruhe (TH), Germany
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
48 pages, May 5, 2009
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