System dynamics modelling of firm value

Abstract

PurposeThe purpose of this paper is to assess how investment, financing and dividend policies may affect firm value.Design/methodology/approachThe paper develops a system dynamics‐based model by using “financial management approach,” “capital structure approach,” “resource‐based approach,” and “sustainable growth approach” to identify investment, financing and dividend policies that may help maximize the firm value.FindingsAdequate investment in productive assets is the first step to achieve value maximization objective. Low debt capital structure plays a dominant role to maximize the firm value, contrary to the suggestions generally found in corporate finance literature. Rather insignificant role of firm's short‐term financing policy is observed. A consistently stable dividend policy is also a prerequisite of firm value maximization.Research limitations/implicationsThe limitations of this study include: the competitors' actions are not modeled; human resources and other intangible resources are not modeled; instead of market debt, debt is assumed to be bank debt. Future studies may bring in the competitors' actions, intangible assets including human resources, and may also consider to model debt as market debt.Practical implicationsThe firms operating in favorable product market conditions should keep their operating and financial risks low which will also maximize their firm value. On the other hand, the firms facing unfavorable product market conditions have to make a trade‐off to minimize operating risk vs financial risk.Originality/valueUsually the studies test one policy in isolation. However, this may probably be the first study that simultaneously tests various combinations of investment, financing and dividend policies that may help maximize the firm value.