The influence of moral hazard on investment in financially constrained and unconstrained firms

•Add decreasing returns to scale to the continuous investment model of Tirole (2006).•Decreasing returns to scale imply an optimum investment level.•Firms that hold cash above the optimum level face a free cash flow problem.•Firms that hold cash below the optimum level are disciplined by the lender....

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Bibliographic Details
Published in:Finance research letters 2014-09, Vol.11 (3), p.272-281
Main Authors: Keefe, Michael O’Connor, Kieschnick, Robert
Format: Article
Language:English
Subjects:
Cash flow
Financial constraints
Free cash flow
Investment
Investment companies
Moral Hazard
Studies
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Summary:•Add decreasing returns to scale to the continuous investment model of Tirole (2006).•Decreasing returns to scale imply an optimum investment level.•Firms that hold cash above the optimum level face a free cash flow problem.•Firms that hold cash below the optimum level are disciplined by the lender.•Model unifies free cash flow and financial flexibility perspectives. We extend Triole (2006) to link together two seemingly different cases – firms facing potential free cash flow problems versus firms facing financial constraints. The model predicts a large number of disparate findings in the empirical literature and so demonstrates its usefulness.
ISSN:1544-6123
1544-6131
DOI:10.1016/j.frl.2014.01.001