This study examines how the investment opportunity set of the firm affects financing choices the firm makes. In a two-period, one decision, no-tax model, we show that firms characterized by a high level of investment opportunities in future periods issue equity and convertible securities while firms with fewer investment opportunities in future periods issue straight debt. Our empirical design improves upon previous studies in two important ways. First, we treat convertible debt separately from straight debt. Second, in addition to examining the correlation between investment opportunity and debt-asset ratios, we examine the incremental financing decision using discrete choice analysis. We find that the level of investment opportunities of firms making public issues of equity and convertible debt are higher than those issuing straight debt. Also, there is a negative correlation between investment opportunities and debt-asset ratios. We interpret these results to mean that investment opportunities are an important determinant of the firm’s financing policy. The direction of this relationship is the same as that predicted by the tax models of DeAngelo and Masulis (1980) and Dotan and Ravid (1985), and agency models of Myers (1977), Jensen (1986) and Stulz (1990). / Ph. D.

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