External Funding and Irreversible Investment

This paper endogenizes the cost of external funds and explores the implications on irreversible investments. The investment strategy incorporates equilibrium feedback that result from a bargaining process between the firm and a lender. Contrary to debt issuance, tax benefits and distress costs cannot be internalized by the firm. “Bad news” are less costly for the firm that has incentives to accelerate investment whereas creditors intend to delay it; underinvestment or overinvestment is determined by each party relative bargaining power and the size of bankruptcy costs. Default and credit market imperfections raise the cost of capital, which dampens the value of waiting. The impact of assets already in place, bankruptcy costs and leverage level are also examined. JEL classification: C78, D92, G32, G33.