Optimal dividend policy and growth option (Q2463700)

The authors consider the interaction between dividend policy and investment decisions as a singular control problem. Such an objective leads the authors to deal with a mixed singular control/optimal stopping problem that is solved by establishing a connection with an ``pure'' optimal stopping problem. In connection with the activity of some firm with a technology in place and growth option, it is shown that the firm value under the optimal dividend/investment policy coincides with the value function of the optimal stopping problem whose payoff function is the maximum of values of the firm computed under the two strategies: (i) never invest in the growth option, (ii) defer dividend distributions and invest optimally in the growth option. The proof of the equivalence between the mixed and ``pure'' problem is based on a verification procedure for stochastic control. From the detailed analysis based on properties of local time, the optimal dividend/investment policy is constructed. The effects of financing constraints on dividend policy and investment decision with respect to the situation where the firm has unlimited cash are studied.