Speaker: Yuan Tian from Ryukoku University, Kyoto, Japan
Title: The Interaction of Leverage and Liquidity Management with Dynamic Investment
Abstract: Aiming to provide a quantitative guidance for integrating the liability management (such as debt and equity financing) with the asset management (such as investment and liquidity reserve maintenance), we develop a theoretical model of dynamic investment, debt financing, dividend payout, and external equity financing/liquidation for financially constrained firms. Mathematically, to solve the recursive equilibrium of the problem to determine the equity and debt values, we formulate it as a variational inequality with a fixed-point structure embedded. Compared to the traditional corporate finance literature that mainly focuses on capital structure, we highlight the central importance of joint management of leverage and liquidity in corporate decision making in the presence of external financing costs. In particular, a novel trade-off (liquidity-boosting vs. liquidity-draining) brought by debt enables us to shed light on the interaction of leverage and liquidity management. Rich implications through the lens of liquidity on Tobin’s q and investment, underestimation of debt overhang, integration of pecking order and trade-off theories, deleveraging are also provided.