Prof. Qi Wu, gave a lecture titled “Switching Costs, Operating Policy and Financing Decisions” at AMSS on 9, December 2020.
Greater technological flexibility enables quicker responses to changing market conditions. Operational decisions, such as when to start and when to idle production, however, are not made solely on the basis of technology, but are impacted by financial choices. We consider a range of technologies that differ in flexibility, measured by switching cost. When firms possess a flexible technology with switching cost below a low critical level or an inflexible technology, with switching costs above a high level, equity maximizing second best operating policies and capital structures are identical to firm maximizing first best policies. However between these two thresholds, agency issues lead to losses. In this middle region, as switching costs increase, optimal second best operating policies are maintained as first best, but this can only be accomplished by reducing debt below first best levels. As switching costs continue to increase, lower and lower debt levels are required to maintain the first best operating policy. Eventually the sacrifices made by giving up the benefits of the tax shield so as to induce no risk shifting are so great that the optimal second best policy suddenly jumps, takes on much more debt than first best policies, and simultaneously risk shifting ensues. Only, when switching costs reach the higher threshold are second best policies restored to first best with agency costs disappearing. The managerial consequences of altering technological on both operating policies and financing choices are explored.
Prof. Qi Wu is Associate Professor and Lewis-Progressive Fellow at Case Western Reserve University. She received her doctoral degree in information, risk and operations management from the University of Texas at Austin and joined CWRU in 2013. Her work focuses on empirical research in operations management, finance and operations management interface, risk management, and supply chain contracts. Her articles appear in journals such as Mathematics of Operations Research, Production and Operations Management, Operations Research Letters, and Risk and Decision Analysis.
