Time-to-Build and Leverage Dynamics
39 Pages Posted: 31 May 2012
Date Written: March 23, 2012
We consider the role of construction lags or time-to-build (TTB) in a firm’s dynamic investment and financing decisions. We conjecture that construction lags can lead firms to finance large projects with equity so as to maintain financial flexibility during the construction period. After project completion, firms will substitute towards debt financing. Using a unique measure of TTB, we uncover several facts regarding leverage dynamics that are consistent with this theory and are not easily explained by other theories. Firms occasionally undertake large discrete investment projects, often after sharp increases in stock price, and these projects are associated with active capital structure adjustments. The longer the TTB for a given project, the more firms rely on equity in the financing of the project. As project completion nears, firms tend to substitute from equity towards debt financing. The incremental information of TTB factors in predicting capital structure choices appears to be substantial.
Keywords: capital structure, leverage, investment dynamics
JEL Classification: G31, G32
Suggested Citation: Suggested Citation