Working Paper: NBER ID: w1097
Authors: Fumio Hayashi
Abstract: This paper attempts to provide a framework for analyzing the interaction between real decisions (concerning investment and factor inputs)and financial decisions (concerning debt and new share issues) of a corporation. The model carries a rich menu of tax rates and explicitly incorporates bankruptcy and default. The firm's multi-period optimization problem is set up where real and financial decisions are simultaneously determined to maximize the value of the firm which is the market price of uncertain future dividends. The main results of the paper are as follows:if the firm's after-tax profits are small relative to investment, the firm finances new investment by retentions and debt; if they are large relative to investment, financing additional investment is done through new shares and debt; in the intermediate case, additional investment is financed entirely by debt.
Keywords: investment; financial policy; bankruptcy; corporate finance
JEL Codes: G32; D92
Edges that are evidenced by causal inference methods are in orange, and the rest are in light blue.
| Cause | Effect |
|---|---|
| After-tax profits are small relative to investment (G31) | Financing occurs through retentions and debt (G32) |
| After-tax profits are large relative to investment (G31) | Financing occurs through new shares and debt (G32) |
| After-tax profits are intermediate (H29) | Financing occurs entirely through debt (G32) |
| Financial structure (G32) | Investment decisions (G11) |