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

  • Samuel, Cherian
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    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
    Date of revision:
    Handle: RePEc:wbk:wbrwps:1656
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