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EXIT OPTIONS AND DIVIDEND POLICY UNDER LIQUIDITY CONSTRAINTS
Author(s) -
MURTO PAULI,
TERVIÖ MARKO
Publication year - 2014
Publication title -
international economic review
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 2.658
H-Index - 86
eISSN - 1468-2354
pISSN - 0020-6598
DOI - 10.1111/iere.12046
Subject(s) - market liquidity , monetary economics , transaction cost , profitability index , economics , cash , cash flow , dividend , constraint (computer aided design) , operating cash flow , business , microeconomics , finance , mechanical engineering , engineering
We introduce a post‐entry liquidity constraint to the standard model of a firm with serially correlated profitability and an irreversible exit decision. We assume that firms with no cash holdings and negative cash flow must either exit or raise new cash at a transaction cost. This creates a precautionary motive for holding cash, which must be traded off against the liquidity cost of holding cash. We characterize the optimal exit and payout policy. The direct effect of financial frictions is to impose inefficient exit, but there is also an indirect effect through higher equilibrium price that leads to inefficient survival.