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Estimating irreversible investment with financial constraints: an application of switching regression models

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Abstract:

This analysis investigates irreversible investment with financial constraints. When investment is irreversible, zero investment can be optimal and investment becomes lumpy. Because external funds are not a perfect substitute for internal funds, financially constrained firms invest differently than unconstrained firms. To incorporate both irreversibility and financial constraints into estimations, the analysis develops a switching regression model that depends on the real options theory of capital investment. The analysis investigates three US industries: the oil refining, communications equipment manufacturing and semiconductor manufacturing industries. The analysis shows that internal funds affect investment if a firm is financially constrained.

Document Type: Research Article

DOI: https://doi.org/10.1080/00036840701579218

Affiliations: Department of Economics, Asia University, Tokyo, Japan 180-8629

Publication date: 2010-01-01

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