FINANCING CONSTRAINTS AND REORDERING RULES

Constraints on external finance modify a simple inventory investment d ecision. Optimal policy is no action when cash holdings are less than threshold levels (the control boundaries) which are functions of the c urrent level of inventories. On the control boundaries additional cash is used for inventory replenishment, when inventory holdings are belo w the level which would be held in the absence of financing constraint s, and for dividend payment, when inventory holdings are equal to or e xceed this level. A fixed boundary at all inventory levels is used as an approximation to the fully optimal control allowing computation of the behaviour of aggregate inventory and cash holdings for a populatio n of financially constrained firms. There is a pronounced and extended dynamic response from inventory investment following aggregate distur bances to cash holdings, to prices, and to the standard error of the d iffusion process for cash holdings. This contrasts with the unconstrai ned case where such shocks have no effect on either inventory holdings or inventory investment.