A note on optimal capital stock and financing constraints

• Published in: Economic modelling 2012-07, Vol.29 (4), p.1177-1180
• Main Authors: Saltari, E., Travaglini, G.
• Format: Article
• Language: English
• Subjects: Brownian motion; Capital stock; Economic models; Financial control; Financing; Financing constraints; Investment; Investment policy; Studies; Uncertainty; Value
• ISSN: 0264-9993; 1873-6122
• DOI: 10.1016/j.econmod.2012.04.006

There is a robust literature on the relationship between financing constraints and real investment. Little has been said on the relationship between financing constraints and capital stock in the long run. This note focuses on this last issue. To keep the model tractable, we assume that the firm employs a single input, and this input is used as collateral. We get three main results. Firstly, we show that the optimal capital stock chosen by a firm is affected by financing constraints even when they are slack at the current time. Secondly, we show that the net present value of the potentially constrained firm is always smaller than the one of the never constrained firm. Finally, we find that in the presence of latent financing constraints the firm does not limit itself to reducing its investment when the upper limit is reached. What it actually does is to lower its long run optimal capital stock, amplifying the effects of constraints in the long run. ► There is huge literature on financing constraints and investment. ► Little has been said on financing constraints and desired capital stock. ► We show that desired capital is affected by constraints even when they are slack. ► We show that the potentially constrained firm reduces its desired capital stock. ► This behavior amplifies the negative effects of financing constraints over time.