The role of non-convex costs in firms' investment and financial dynamics

Abstract

This paper shows that non-convex costs of financial adjustment are quantitatively relevant for explaining firm dynamics. First, empirically, financial activity is lumpy, more than investment activity. Second, non-convex costs are necessary, in the context of a dynamic investment and financing model, to rationalize this lumpiness. Two versions of the model, with and without non-convex costs, are compared. Only the non-convex costs version replicates the dynamics in the data, generating financial lumpiness higher than investment lumpiness. Other predictions of the model with respect to investment and finance are discussed.