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Internal funds and the investment function

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  • Guy V. G. Stevens

Abstract

An extensive and increasingly persuasive body of empirical evidence has linked a firm's fixed investment expenditure to its supply of internally generated funds. The central concerns of this paper are (1) the theoretical justifiability of such empirically-based investment functions, particularly those where internal funds affect only the speed of adjustment, and (2) the dynamic properties of this latter class of investment functions. A class of models is explored featuring intertemporal profit maximization under conditions of increasing costs of external finance (attributable to bankruptcy or agency costs). The paper shows that, for a major part of the optimal investment path, the function implied by the theory is remarkably close to the most promising variant found empirically: the supply of internal funds affects the speed of adjustment, but not the level of the optimal capital stock. Such investment functions possess the unusual dynamic property that the speed of adjustment increases monotonically along the optimal path.

Suggested Citation

  • Guy V. G. Stevens, 1993. "Internal funds and the investment function," International Finance Discussion Papers 450, Board of Governors of the Federal Reserve System (U.S.).
    • Handle: RePEc:fip:fedgif:450
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    References listed on IDEAS

    as
    1. Stevens, Guy V G, 1974. "On the Impact of Uncertainty on the Value and Investment of the Neoclassical Firm," American Economic Review, American Economic Association, vol. 64(3), pages 319-336, June.
    2. Gardner, Roy & Sheldon, Russell, 1975. "Financial Conditions and the Time Path of Equipment Expenditures," The Review of Economics and Statistics, MIT Press, vol. 57(2), pages 164-170, May.
    3. Robert Eisner, 1978. "Factors in Business Investment," NBER Books, National Bureau of Economic Research, Inc, number eisn78-1, March.
    4. Myers, Stewart C. & Majluf, Nicholas S., 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Journal of Financial Economics, Elsevier, vol. 13(2), pages 187-221, June.
    5. Haugen, Robert A & Senbet, Lemma W, 1978. "The Insignificance of Bankruptcy Costs to the Theory of Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 33(2), pages 383-393, May.
    6. Joseph E. Stiglitz, 1972. "Some Aspects of the Pure Theory of Corporate Finance: Bankruptcies and Take-Overs," Bell Journal of Economics, The RAND Corporation, vol. 3(2), pages 458-482, Autumn.
    7. Steven M. Fazzari & R. Glenn Hubbard & Bruce C. Petersen, 1988. "Financing Constraints and Corporate Investment," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(1), pages 141-206.
    8. Stewart C. Myers & Nicholas S. Majluf, 1984. "Corporate Financing and Investment Decisions When Firms Have InformationThat Investors Do Not Have," NBER Working Papers 1396, National Bureau of Economic Research, Inc.
    9. Jensen, Michael C. & Meckling, William H., 1976. "Theory of the firm: Managerial behavior, agency costs and ownership structure," Journal of Financial Economics, Elsevier, vol. 3(4), pages 305-360, October.
    10. Abel, Andrew B, 1985. "A Stochastic Model of Investment, Marginal q and the Market Value of the Firm," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 26(2), pages 305-322, June.
    11. Guy V. G. Stevens, 1986. "Internal funds and the investment functions: exploring the theoretical justification of some empirical results," Special Studies Papers 199, Board of Governors of the Federal Reserve System (U.S.).
    12. Scott, James H, Jr, 1977. "Bankruptcy, Secured Debt, and Optimal Capital Structure," Journal of Finance, American Finance Association, vol. 32(1), pages 1-19, March.
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