We develop a model that endogenizes dynamic financing, investment, and cash retention/payout policies in order to analyze the effect of financial flexibility on firm value. We show that the value of financing flexibility depends on the costs of external financing, the level of corporate and personal tax rates that determine the effective cost of holding cash, the firm's growth potential and maturity, and the reversibility of capital. Through simulations, we demonstrate that firms facing financing frictions should simultaneously borrow and lend, and we examine the nature of dynamic debt and liquidity policies and the value associated with corporate liquidity. Copyright (c) 2008 The American Finance Association.

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W e analyze the value created by a dynamic integrated risk management strategy involving liquidity management, derivatives hedging, and operating flexibility, in the presence of several frictions. We show that liquidity serves a critical and distinct role in risk management, justifying high levels of cash. We find that the marginal value associated with derivatives hedging is likely to be low, though we explain why some empirical studies find a higher value. We explore the complex interactions between operating flexibility and financial risk management, finding that substitution effects are nonmonotonic and are affected by operating leverage, the nature of operating flexibility, and the effectiveness of the hedging instrument.

We provide a general valuation approach for capital budgeting decisions involving the modularization in the design of a system. Within the framework developed by Baldwin and Clark (Baldwin, C. Y., K. B. Clark. 2000. Design Rules: The Power of Modularity. MIT Press, Cambridge, MA), we implement a valuation approach using a numerical procedure based on the least-squares Monte Carlo method proposed by Longstaff and Schwartz (Longstaff, F. A., E. S. Schwartz. 2001. Valuing American options by simulation: A simple least-squares approach. Rev. Financial Stud. 14(1) 113-147). The approach is accurate, general, and flexible.real options, modularity, least-squares Monte Carlo