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The investment decision : a re-examination of competing theories using panel data

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Author Info
Samuel, Cherian
Abstract

In the United States, gross business fixed investments constitute about 10 percent of the Gross National Product (GNP). Such investments may represent GNP's most important component because: a) plant and equipment have a long-term effect on the economy's productive capacity, b) changes in investment spending directly affect employment levels and workers'incomes in durable goods industries, and c) supply and demand are sensitive to investment changes. Economists have long been concerned about what determines capital spending investments. Using data for US manufacturing firms for 1972-90, the author compares five investment theories: accelerator theory, cash flow theory, neoclassical theory, modified neoclassical theory and Q theory. If the results for cross-section regressions can be viewed as representing the long-term equilibrium, the single most important determinant of capital spending appears to be cash flow. Apparently, managers care more about cash flow and cost of capitalthan about stock market signals and the level of output. And at the firm level, managerial perceptions about fundamentals are more important that market perceptions. For managers, the stock market may be a side show to capital spending decisions. To generalize in a way useful for developing countries: firm level financial decisions are closely linked to real decisions in the economy. Internal finance is the most important use of funds so there is a close relationship between real and financial decisions.

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Paper provided by The World Bank in its series Policy Research Working Paper Series with number 1656.

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Date of creation: 30 Sep 1996
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Handle: RePEc:wbk:wbrwps:1656

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Keywords: Environmental Economics&Policies; ICT Policy and Strategies; Economic Theory&Research; Decentralization; International Terrorism&Counterterrorism; Environmental Economics&Policies; Economic Theory&Research; ICT Policy and Strategies; International Terrorism&Counterterrorism; Educational Technology and Distance Education;

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Please report citation or reference errors to , or , if you are the registered author of the cited work, log in to your RePEc Author Service profile, click on "citations" and make appropriate adjustments.:
  1. Samuel, Cherian, 1996. "Stock market and investment : the governance role of the market," Policy Research Working Paper Series 1578, The World Bank. [Downloadable!]
  2. Bleaney, Michael & Greenaway, David, 1993. "Adjustment to external imbalance and investment slumps in developing countries," European Economic Review, Elsevier, vol. 37(2-3), pages 577-585, April. [Downloadable!] (restricted)
  3. Jorgenson, Dale W, 1971. "Econometric Studies of Investment Behavior: A Survey," Journal of Economic Literature, American Economic Association, vol. 9(4), pages 1111-47, December. [Downloadable!] (restricted)
  4. Benjamin M. Friedman & David I. Laibson, 1989. "Economic Implications of Extraordinary Movements in Stock Prices," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 20(1989-2), pages 137-190. [Downloadable!]
  5. Grabowski, Henry G & Mueller, Dennis C, 1972. "Managerial and Stockholder Welfare Models of Firm Expenditures," The Review of Economics and Statistics, MIT Press, vol. 54(1), pages 9-24, February. [Downloadable!] (restricted)
  6. William C. Brainard & James Tobin, 1968. "Pitfalls in Financial Model-Building," Cowles Foundation Discussion Papers 244, Cowles Foundation, Yale University. [Downloadable!]
  7. Steven Fazzari & R. Glenn Hubbard & Bruce C. Petersen, 1988. "Financing Constraints and Corporate Investment," NBER Working Papers 2387, National Bureau of Economic Research, Inc. [Downloadable!] (restricted)
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  8. Jaramillo, Fidel & Schiantarelli, Fabio & Weiss, Andrew, 1993. "The effect of financial liberalization on allocation of credit : panel data evidence for Ecuador," Policy Research Working Paper Series 1092, The World Bank. [Downloadable!]
  9. Randall Morck & Andrei Shleifer & Robert W. Vishny, 1990. "The Stock Market and Investment: Is the Market a Sideshow?," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 21(1990-2), pages 157-216. [Downloadable!]
  10. Lawrence H. Summers, 1981. "Taxation and Corporate Investment: A q-Theory Approach," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 12(1981-1), pages 67-140. [Downloadable!]
  11. Hausman, Jerry A, 1978. "Specification Tests in Econometrics," Econometrica, Econometric Society, vol. 46(6), pages 1251-71, November. [Downloadable!] (restricted)
  12. Stiglitz, Joseph E & Weiss, Andrew, 1981. "Credit Rationing in Markets with Imperfect Information," American Economic Review, American Economic Association, vol. 71(3), pages 393-410, June. [Downloadable!] (restricted)
  13. Tobin, James, 1969. "A General Equilibrium Approach to Monetary Theory," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 1(1), pages 15-29, February. [Downloadable!] (restricted)
  14. Dale Jorgenson, 1967. "The Theory of Investment Behavior," NBER Chapters, in: Determinants of Investment Behavior, pages 129-188 National Bureau of Economic Research, Inc. [Downloadable!]
  15. Eisner, Robert & Nadiri, M Ishaq, 1970. "Neoclassical Theory of Investment Behavior: A Comment," The Review of Economics and Statistics, MIT Press, vol. 52(2), pages 216-22, May. [Downloadable!] (restricted)
  16. Harris, John R & Schiantarelli, Fabio & Siregar, Miranda G, 1994. "The Effect of Financial Liberalization on the Capital Structure and Investment Decisions of Indonesian Manufacturing Establishments," World Bank Economic Review, Oxford University Press, vol. 8(1), pages 17-47, January.
  17. Rhee, C. & Rhee, W., 1991. "Fundamental Value and Investment: Micro Data Evidence," RCER Working Papers 282, University of Rochester - Center for Economic Research (RCER).
  18. Hoshi, Takeo & Kashyap, Anil & Scharfstein, David, 1991. "Corporate Structure, Liquidity, and Investment: Evidence from Japanese Industrial Groups," The Quarterly Journal of Economics, MIT Press, vol. 106(1), pages 33-60, February. [Downloadable!] (restricted)
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