Three Essays on Dynamic Corporate Finance in Continuous Time
This dissertation is composed of three related essays that contribute to the literature on dynamic corporate finance theory. In the first essay, we study dynamic group decisions by examining how heterogeneity in risk preferences of decision-makers influences the joint dynamic of financial policies. Each member receives a non-tradable claim that reflects her risk preference. Claims are convex, S-shaped and concave for investors with the lowest, intermediate and highest level of risk aversion, respectively. The group's optimal investment policy is a time-varying weighted average of investors' optimal policies. Debt is safe and procyclical as the firm dynamically rebalances in response to shocks. We show that only non-linear contracts in conjunction with dynamic investment and financing policies can substitute for rigid group membership. The second essay explores how information acquisition affects a firm's learning, investment, payout and utility under incomplete information and imperfect learning. Extra information improves learning, induces more aggressive investment and encourages higher payout. However, the costs incurred can overturn the benefits generated and lead to further inefficiency, dampening the motivation to search for information. The demand for information is shown to be time-varying. It increases when the investment environment is volatile, and when the investors' marginal utility of consumption is high. It decreases when the firm's estimated rate of return from investment is high as learning becomes a second-order concern. The third essay studies the interaction of individual firms' leverage dynamics and product market competition. Equity holders are unable to commit to a future debt level and determine the firms' financing, production, entry and exit decisions. Non-commitment makes debt financing more expensive as debt holders foresee a ratchet up in future debt, raising the entry barriers and hindering new entries into the market. This results in lower product market competition, lower total output and higher output prices. The absence of debt policy commitment reshapes the stationary firm distribution, increases the market turnover rate and escalates the industry leverage.
corporate finance, group decisions, risk preference, financial policies, governance, private firms, heterogeneous preferences, capital structure, learning, information acquisition, investment decisions, payout policy, non-commitment, leverage ratchet effect, industry dynamics, product market competition, debt-equity conflicts
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