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Investment timing and leverage decisions with caps and floors
This paper studies investment timing and leverage decisions of firms under caps and floors. Caps and floors have significant effects, not only on investment timing and firm value, but also on leverage ratios and credit spreads. With leverage, a floor has a moderate effect if below a critical level. Above that level, the firm tends to issue less risky debt, being even able to issue risk-free debt, and the floor has a more significant effect, accelerating investment. A lower cap deters investment, increases leverage, but reduces credit spreads. When combined with a floor, in a collar regime, the effects of the cap become non-monotonic, as the firm is able to issue risk-free debt for intermediate levels of the cap. Uncertainty always deters investment, but the effects on leverage and credit spreads are non-monotonic.