Market frictions and corporate finance: an overview paper (Q475313): Difference between revisions

The authors review some topics in continuous-time corporate finance, mainly based on the results in [\textit{M. Jeanblanc-Picqué} and \textit{A. N. Shiryaev}, Russ. Math. Surv. 50, No. 2, 257--277 (1995); translation from Usp. Mat. Nauk 50, No. 2, 25--46 (1995; Zbl 0878.90014)] and in [\textit{R. Radner} and \textit{L. Shepp}, ``Risk vs. profit potential: a model for corporate strategy'', J. Econ. Dyn. Control 20, No. 8, 1373--1393 (1996; \url{doi:10.1016/0165-1889(95)00904-3})]. Firm's earnings are modeled as a diffusion \( dY_t=\mu dt+\sigma dW_t \) and the manager is assumed to maximize the discounted expected stream of dividends. Section 2 considers the optimal dividend policy with no refinancing opportunity. Bankruptcy occurs then when the net earnings of dividends become negative. The distribution of dividends contributes to utility but raises the risk of bankruptcy. Balancing the two effects through HJB leads to a boundary in firm's reserves below which no dividends are distributed. Equity issues are just as negative dividends but they bear a fixed cost and are a pure jump process. If the issue costs are above a given threshold there will be no issue; if below, equity will be issued exactly at the bankruptcy barrier. In Section 4 the same problem is considered from the perspective of a bank. An updated and wide literary review is considered in Section 5.