Dynamic Financing and Optimal Debt Management Policy

This paper links firm's investment policy to its debt management policy. To achieve this goal, a dynamic contracting model is built to derive an optimal contract in the environment where the firm's policies affect the financing terms. This is achieved by arriving at collateralized debt which endogenously constrains the firm's ability to finance its investment opportunities. Following the characterization of the optimal policies, I replicate the optimal state-contingent debt contract by the real-world noncontingent debt with maturity. This replication is important because the assumption of a state-contingent contract is empirically counterfactual. I do this replication based on the solution of the model for two states of the world due to the increasing computational complexity of the problem in productivity states and after that, I calibrate and produce a stochastic panel of the economy to match the existing empirical moments in the literature. The moments generated from the simulation match the data fairly well, in spite of the absence of adjustment costs and the possibility of equity issuances.