This paper examines how a firm's optimal investment, financing, and risk management policies are interconnected when considering external financing and payout costs from the shareholder's perspective. The paper finds that a firm's optimal cash inventory policy follows a double-barrier approach, where the firm raises new funds when cash is depleted and pays out cash to shareholders when the cash-capital ratio hits an upper boundary. Between these boundaries, the firm continuously adjusts investment based on cash flow. Additionally, the firm hedges earnings risk by investing in assets uncorrelated with its core business risk, which reduces cash inventory volatility. The paper also finds an inverse relationship between marginal Tobin's Q and investment when credit is used, and that constrained firms may
This paper examines how a firm's optimal investment, financing, and risk management policies are interconnected when considering external financing and payout costs from the shareholder's perspective. The paper finds that a firm's optimal cash inventory policy follows a double-barrier approach, where the firm raises new funds when cash is depleted and pays out cash to shareholders when the cash-capital ratio hits an upper boundary. Between these boundaries, the firm continuously adjusts investment based on cash flow. Additionally, the firm hedges earnings risk by investing in assets uncorrelated with its core business risk, which reduces cash inventory volatility. The paper also finds an inverse relationship between marginal Tobin's Q and investment when credit is used, and that constrained firms may
This paper examines how a firm's optimal investment, financing, and risk management policies are interconnected when considering external financing and payout costs from the shareholder's perspective. The paper finds that a firm's optimal cash inventory policy follows a double-barrier approach, where the firm raises new funds when cash is depleted and pays out cash to shareholders when the cash-capital ratio hits an upper boundary. Between these boundaries, the firm continuously adjusts investment based on cash flow. Additionally, the firm hedges earnings risk by investing in assets uncorrelated with its core business risk, which reduces cash inventory volatility. The paper also finds an inverse relationship between marginal Tobin's Q and investment when credit is used, and that constrained firms may
A Unified theory of Tobins Q, Corporate Investment, Financing and Risk
Management by Patrick Bolton, Hui Chen and Neng Wang
Application: This research paper only looks at risk management from the shareholders perspective. However, the application of Tobins to this research paper is vindicated by the inference that how in the presence of external financing and payout costs the firms optimal investment, financing and risk management policies are all interconnected. The firms optimal cash inventory policy takes the form of a double-barrier policy where the firm raises new funds only when its cash inventory is entirely depleted, and pays out cash to shareholders only when its cash-capital ratio hits an endogenous upper barrier. In between these two barriers, the firm continuously adjusts its investment to take account of positive or negative cash-flow shocks. In addition the firm also hedges its earnings risk by investing in financial assets that are not perfectly correlated with its underlying business risk. The benefit of such hedges is to reduce the volatility of the firms cash inventory.
Example: We find an inverse relation between marginal Tobins q and investment when the firm draws on its credit line. We also find that financially constrained firms may have a lower equity beta in equilibrium because these firms tend to hold higher precautionary cash inventories.
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