An exact solution for the investment and value of a firm facing uncertainty, adjustment costs, and irreversibility

This paper derives closed-form solutions for the investment and value of a competitive firm with a constant-returns-to-scale production function and convex costs of adjustment. Solutions are derived for the case of irreversible investment as well as for reversible investment. Optimal investment is a...

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Bibliographic Details
Published in:Journal of economic dynamics & control 1997-05, Vol.21 (4), p.831-852
Main Authors: Abel, Andrew B., Eberly, Janice C.
Format: Article
Language:English
Subjects:
Adjustment costs
Economic control
Economic dynamics
Economic models
Economic theory
Economies of scale
Firm theory
Investment
Irreversibility
Production functions
Studies
Uncertainty
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Summary:This paper derives closed-form solutions for the investment and value of a competitive firm with a constant-returns-to-scale production function and convex costs of adjustment. Solutions are derived for the case of irreversible investment as well as for reversible investment. Optimal investment is a non-decreasing function of q, the shadow value of capital. Relative to the case of reversible investment, the introduction of irreversibility does not affect q, but it reduces the fundamental value of the firm.
ISSN:0165-1889
1879-1743
DOI:10.1016/S0165-1889(97)00005-5