Investment Timing with Costly Search for Financing

Abstract

I develop a dynamic model of investment timing in which firms must first choose when to search for external financing. Search is costly and the arrival of investors is uncertain, leading to delay in financing and investment. Depending on parameters, my model can predict simultaneous financing and investment or early financing prior to investment. Additionally, the supply of financing has a nonmonotonic effect on search behavior. This realistic generalization of the investment timing problem is straightforward to extend. I find that subjecting firms to insolvency shocks reduces the value of the option to finance later, and taxes increase the impact of such shocks. When I introduce time varying financial conditions, the model predicts investment waves, financing waves, market timing, and IPO withdrawals consistent with empirical evidence. Finally, adding heterogeneous investors produces empirical predictions on investor-firm matching.