“Financing Uncertain Growth” by LI Yin, Jay
LI Yin, Jay
the City University of Hong Kong
David C. Mauer
University of Texas at Dallas
Reflecting the uncertain emergence of growth opportunities and the reality that corporate growth materializes only when growth opportunities and firm conditions coalesce, we model a growth opportunity as randomly arriving and quickly dissipating in a dynamic trade-off framework. While the firm can optimally time its capital restructuring, the uncertain and short-lived growth opportunity gives the firm no control over the timing of investment. Investment may thus occur at a time that is not optimal to restructure capital, resulting in a potential timing discrepancy between investment and debt financing. This timing discrepancy can reconcile a number of puzzling findings in the literature: large leverage jumps without change in investment, greater stock underperformance after equity offerings than after debt offerings, debt conservatism, and observational equity market timing. Our analysis also reveals positive interactions between growth opportunities and financial flexibility (i.e., growth-financing synergies), and suggests that firms with monopolistic access to growth opportunities tend to be more conservative in using debt but prefer more flexible debt terms than firms with uncertain growth opportunities. The value of financial restructuring is relatively small, however, which helps explain the persistence of capital structure and infrequent capital structure rebalancing.