Real Estate Risk, Corporate Investment and Financing Choice

This paper examines how asset risk impacts corporate investment and financing decisions. We derive a general model that incorporates risk, adjustment cost, and depreciation features of assets-in-place into investment decisions. The model suggests that the risk and adjustment cost of assets-in-place reduce both corporate investment and financing. We empirically test the model in a panel of US firms from 1985 to 2010 with data on real estate risk exposure. Evidence shows that real estate risk is negatively associated with firms’ long-term investments and long-term external financing in equity and debt. However, the effect on leverage depends on risk measures and asset types. Overall, in contrast to previously documented effect of the real estate value, real estate risk exposure exhibits mostly the opposite effects on investment, financing, and capital structure.