Optimal Investment under Credit Constraints

We analyze in this paper the interaction between financing and investment decisions in presence of debt issuance costs. We find that, while debt issuance costs reduce tax shields, tax shields induce a higher investment trigger. Moreover, the investment trigger is a non-monotonic function of the borrowing capacity. Indeed, as credit constraints relax, entrepreneurs with small debt capacity speed up investment to exploit tax shields, whereas those with large debt capacity postpone investment to minimize default risk.