Exit Options and Dividend Policy under Liquidity Constraints

We introduce a post-entry liquidity constraint to the standard model of a …rm with serially correlated pro…tability and an irreversible exit decision. We assume that …rms with no cash holdings and negative cash ‡ow must either exit or raise new cash at a transaction cost. This creates a precautionary motive for holding cash, which must be traded o¤ against the liquidity cost of holding cash. We characterize the optimal exit and payout policy. The direct e¤ect of …nancial frictions is to impose ine¢ cient exit, but there is also an indirect e¤ect through higher equilibrium price which leads to ine¢ cient survival. (D81, D92, G35) We thank the Editor, two anonymous referees, Richard Friberg, Chris Hennessy, Mitri Kitti, Niku Määttänen, Juuso Välimäki, Johan Walden, and numerous seminar audiences for helpful comments, and Jia Yu for excellent research assistance. Murto thanks the Academy of Finland and Terviö thanks the OpenLink Fund at the Coleman Fung Risk Management Research Center at UC Berkeley and the European Research Council (ERC Grant Agreement n. 240970) for …nancial support.