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|A Simple Model of the Firm Life Cycle
|Swiss Finance Institute Research Paper Series
|This paper presents a simple model of the firm life cycle that captures several stylized economic and financial features which usually require considerably more demanding approaches. We study the optimal capital accumulation policy of a financially constrained firm whose revenue is subject to an additive shock. Earnings can be paid as dividends or reinvested with the goal to maximize shareholder value. In our model, the optimal policy of firms is to reinvest earnings (rather than paying dividends) when small, hold precautionary savings, and grow larger than is socially optimal. Smaller firms also have a higher bankruptcy risk and a more volatile market value than larger firms. We observe the leverage effect and excess returns of value stocks. In the presence of business cycles, investment and initial public offerings are pro-cyclical, the default probability is counter-cyclical, and monetary policy increases excess capital holdings but otherwise has a negligible impact.
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