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Problem definition: Modern technologies have made it viable for firms to lower the costs of switching on and off production in response to market changes. In this paper, we explore how production start–stop flexibility impacts joint operating policies, financing, and investment timing decisions. Methodology/results: We develop a continuous-time, optimal stopping model in which equity holders of the firm make operational decisions regarding pausing and restarting production as well as when to default. The degree of production flexibility is measured by switching costs. On the one hand, production flexibility influences the trade-off between tax shields and default costs for the capital structure decision; on the other hand, debt levels impact the equity holders' incentive to use flexibility by pausing and restarting operations. We find that optimal debt usage is not monotone in production flexibility. Specifically, when switching costs are in a low region, the optimal debt level decreases slowly as switching costs increase. As switching costs increase into an intermediate region, the optimal debt level decreases sharply because the firm needs to reduce its debt to ensure the equity holders maintain flexible operating policies. However, when switching costs exceed a threshold, the cost of compromising the use of debt becomes excessive, and the firm substantially increases its debt to gain the full benefit of the tax shield; in so doing, the equity holders forgo flexibility and maintain production continuously until default. This financing strategy affects the firm's investment timing decision, which also exhibits a nonmonotone pattern. Managerial implications: When a firm optimizes the debt usage and investment timing, the incentive of utilizing flexibility embedded in the production technology by the equity holders needs to be taken into account. Our findings also reveal new benefits and guidance for the potential design of incentive contracts to mitigate agency costs. Funding: Q. Wu was supported by Weatherhead School of Management Intramural [Grant IG121420-05-QXW132] for this research. Supplemental Material: The online supplement is available at https://doi.org/10.1287/msom.2022.0213. [ABSTRACT FROM AUTHOR]

We examine how the number of factors and their associated volatility structures affect pricing accuracy and hedging performance in the swaption market. In spite of the fact that low dimensional [...]

We study the effects of disruption risk in a supply chain where one retailer deals with competing risky suppliers who may default during their production lead times. The suppliers, who [...]

This article investigates the pricing of options when a need arises to carry a path-dependent auxiliary state variable. Examples of such problems include the pricing of interest rate claims in [...]

We develop a structural model of the firm that accounts for dilutions, resulting from interest payment shortfalls, and allows cash surpluses to be distributed under a payout policy that permits a combination of dividends and buybacks. Since the model tracks the number of outstanding shares, it can distinguish between claims dependent on the price of a share versus claims that depend on total equity. With a further extension of the model to incorporate employee stock grants, we demonstrate how the prices of traded stock options and employee grants are affected by payout policy. The impact of both dilutions and buybacks on traded option prices and employee grants is shown to be material. This magnitude is further illustrated through a case study involving five technology firms. [ABSTRACT FROM AUTHOR]

Many manufacturing firms have become increasingly flexible in that they can rapidly idle and restart production in response to changing commodity prices. We study how operational flexibility alters both the timing and financing decisions in the firm. We perform this analysis in a dynamic model in which a firm has multiple debt issues and decisions are made to maximize shareholder value. We compare the decisions of a flexible firm, which can temporarily shut down to avoid operational losses, with those of a rigid firm which is not able to stop operating even in states where operational losses occur. On one hand, firms with operational flexibility can better exploit a larger tax shield by taking on more debt. On the other hand, taking on more debt may be less harmful for a rigid firm, since it increases the default threshold thereby reducing the region where operational losses are experienced due to inflexibility. We explore how the two forces trade off between the benefit of tax shield and the cost of default. We find that, even though bondholders charge a higher fair premium for debt issued by the inflexible firm, the rigid firm will utilize more debt. We also show that, all things being equal, firms with operational flexibility invest earlier and use less debt to finance the opportunity. Dynamic models that trade off tax shields with bankruptcy costs and ignore operational flexibility may result in theoretical leverage ratios being biased high. [ABSTRACT FROM AUTHOR]

Any model used to value the quality option in Treasury futures contracts should base its price on the prices of all coupon bonds in their respective deliverable sets. Therefore, most simple equilibrium models cannot be used because they use a finite number of state variables to characterize bond prices. To develop a proper model, a Heath-Jarrow-Morton arbitrage-free pricing methodology is employed. The resulting multifactor model is described.

The problem involving the valuation of a supply contract that operates within the constraints of preset delivery schedules and prices is discussed. In this setup, the manufacturer experiences capacity limits, is subject to variable changes in raw material costs, experiences flexible production costs that are pegged to production rates and is at the mercy of increased charges as a result of production rate increases. The factors involved in the exercise pose a challenge to the optimal determination of production and inventory quantities in such a way that delivery schedules are met and prices are maximized.

The financial economics problem of valuating contingent claims, with values determined by varied sources of uncertainty, is analyzed. The use of efficient algorithms in addressing this problem is proposed, considering that numerical valuation techniques can be computationally costly, while closed form solutions are uncommon. Multinomial models, including the multinomial approximating option model, for valuing claims are discussed.