Dynamic capital structure choice and investment timing

The paper considers the problem of an investor that has the option to acquire a firm. Initially this firm is run as to maximize shareholder value, where the shareholders are risk averse. To do so it has to decide each time on investment and dividend levels. The firm‘s capital stock can be financed by equity and debt, where less solvable firms pay a higher interest rate on debt. Revenue is stochastic. We find that the firm is run such that capital stock and dividends develop in a fixed proportion to the equity. In particular, it turns out that more dividends are paid if the economic environment is more uncertain. We also derive an explicit expression for the threshold value of the equity above which it is optimal for the investor to acquire the firm. This threshold increases in the level of uncertainty reflecting the value of waiting that uncertainty generates.
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This paper was started several years ago at the moment that Engelbert Dockner got the idea to combine Hartl et al. (2002) with the real options approach. Unfortunately, before we were able to finish the paper, he passed away. His coauthors feel honored to finish the paper in his memory.