Financial Constraints and Investment Decisions

In what follows we show that liquidity constraints can affect a firm’s investment even when the constraints are not currently effective. This happens when, at any given time, the firm believes that internal finance is likely to become a constraint in the future. In these circumstances, the value of the firm becomes a non‐monotonic functional form of the fundamental. Thus, in a dynamic setting, the potential barrier to internal liquidity expansion exerts a global effect on the firm’s investment policy, lowering its desired investment profile (Classification JEL: E22, E51).