Entry, Financing, and Bankruptcy Decisions: The Limited Liability Effect

A firm, which has a privileged right to undertake an irreversible investment project, simultaneously determines whether to exercise this project and also how many bonds to issue in the presence of demand uncertainty. The firm will not exercise the project until its net value from investing immediately equals its option value from delaying investment. The firm’s choice of debt levels balances the tax advantage of debt against a cost associated with the event of bankruptcy. The effects of uncertainty, asset specificity, and the costs to purchase capital later on a firm’s entry, financing, and bankruptcy decisions are examined and compared with those in the literature. © 2001 Bureau of Economic and Business Research, University of Illinois. All rights reserved