Workshop in Capital Markets: Erwan Morellec

We develop a model of real investment and cash holdings in which firms face uncertainty regarding their ability to raise funds in the capital markets and have to search for investors when raising outside capital. We provide an explicit characterization of the optimal investment, cash management, and dividend policies for a firm acting in the best interests of incumbent shareholders and show that capital market supply frictions have first-order effects on corporate behavior. We then use the model to explain a key set of stylized facts in corporate finance and to generate a number of novel testable implications relating the supply of funds in capital markets to corporate policy choices.