Equity Financing and Investment in Technological Flexibility
45 Pages Posted: 2 Jan 2006
Date Written: December 2005
We study the interactions between debt/equity financing and strategic (duopoly) technological flexibility choices of firms facing costly bankruptcy. We show that a firm's level of debt financing or financial hardship is an important determinant of the level and type of investment it chooses, either a less costly inflexible technology or a more expensive flexible technology. The level of financial hardship has a non-monotonic effect: as the level of equity financing increases, the choice of technology may switch and the level of investment may follow a bell-shaped or U-shaped path, depending on the differential investment cost, the bankruptcy cost, and whether or not the less costly technology is the best option for an all equity firm. We also show that the level of external financing (debt) may be used strategically in a non-cooperative tacitly collusive way to increase the expected profits of both firms, a firm may use debt as a commitment device to increase its own expected profit, and higher bankruptcy costs may be beneficial to both firms.
Keywords: Financial structure, Flexibility, Investment sensitivity
JEL Classification: L13, G32, D24
Suggested Citation: Suggested Citation