Internal finance and investment : another look
One of the best documented empirical facts in economic research has been the positive relationship between internal finance and cash flows and capital expenditures and investment. But disputes about the analytical basis for the cash flow theory have been largely unresolved. There are two distinct approaches to the cash flow theory of investments: the managerial (managers are primarily interested in maximizing the firm's growth rate) and information theoretic (managers try to maximize shareholder value). Using a panel of US manufacturing firms (1972-90), the author tries to distinguish between the approaches. The results suggest that firms rely on internal finance for capital expenditures because of managerial considerations. The principal shortcoming of the information-theoretic approach is its reliance on dividend practices as a decisive criterion for studying firm heterogeneity. Dividend practices are incapable of distinguishing between managerial and information-theoretic approaches. But one can distinguish between managerial and information-theoretic approaches using such variables as size, exchange listings and the ratio of R&D to sales and make contrasting predictions about the firm's reliance on internal finance for capital expenditures. The evidence shows that the firm's observed reliance of capital expenditures on internal finance is driven by managerial rather than information-theoretic considerations. While no current research directly distinguishes between managerial and information theoretic approaches, preliminary evidence seems to favor the managerial approach. And even though the stock market may play a limited role as a source of finance, policy initiatives to reform the financial sector and develop capital markets are likely to enhance the overall efficiency of the resources allocation process in the economy.
|Date of creation:||31 Oct 1996|
|Contact details of provider:|| Postal: 1818 H Street, N.W., Washington, DC 20433|
Phone: (202) 477-1234
Web page: http://www.worldbank.org/
More information through EDIRC
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.:
- 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.
- 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.
- Dale Jorgenson, 1967. "The Theory of Investment Behavior," NBER Chapters,in: Determinants of Investment Behavior, pages 129-175 National Bureau of Economic Research, Inc.
- Bilsborrow, Richard E, 1977. "The Determinants of Fixed Investment by Manufacturing Firms in a Developing Country," International Economic Review, Department of Economics, University of Pennsylvania and Osaka University Institute of Social and Economic Research Association, vol. 18(3), pages 697-717, October.
- Takeo Hoshi & Anil Kashyap & David Scharfstein, 1991.
"Corporate Structure, Liquidity, and Investment: Evidence from Japanese Industrial Groups,"
The Quarterly Journal of Economics,
Oxford University Press, vol. 106(1), pages 33-60.
- Takeo Hoshi & Anil K. Kashyap & David Scharfstein, 1989. "Corporate structure, liquidity, and investment: evidence from Japanese industrial groups," Finance and Economics Discussion Series 82, Board of Governors of the Federal Reserve System (U.S.).
- Kenneth Arrow, 1962. "Economic Welfare and the Allocation of Resources for Invention," NBER Chapters,in: The Rate and Direction of Inventive Activity: Economic and Social Factors, pages 609-626 National Bureau of Economic Research, Inc.
- Blanchard, Olivier Jean & Lopez-de-Silanes, Florencio & Shleifer, Andrei, 1994. "What do firms do with cash windfalls?," Journal of Financial Economics, Elsevier, vol. 36(3), pages 337-360, December.
- Stulz, ReneM., 1990. "Managerial discretion and optimal financing policies," Journal of Financial Economics, Elsevier, vol. 26(1), pages 3-27, July.
- 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.
- 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.
- Lin, Ji-Chai & Howe, John S, 1990. " Insider Trading in the OTC Market," Journal of Finance, American Finance Association, vol. 45(4), pages 1273-1284, September.
- Ijaz Nabi, 1989. "Investment in Segmented Capital Markets," The Quarterly Journal of Economics, Oxford University Press, vol. 104(3), pages 453-462.
- Bernanke, Ben & Gertler, Mark, 1989. "Agency Costs, Net Worth, and Business Fluctuations," American Economic Review, American Economic Association, vol. 79(1), pages 14-31, March.
- R. Glenn Hubbard & Anil K. Kashyap & Toni M. Whited, 1993. "Internal Finance and Firm Investment," NBER Working Papers 4392, National Bureau of Economic Research, Inc.
- V. V. Chari & Ravi Jagannathan & Aharon R. Ofer, 1987. "Seasonalities in security returns: the case of earnings announcements," Staff Report 110, Federal Reserve Bank of Minneapolis.
- Myers, Stewart C., 1977. "Determinants of corporate borrowing," Journal of Financial Economics, Elsevier, vol. 5(2), pages 147-175, November.
- Myers, Stewart C. & Majluf, Nicolás S., 1945-, 1984. "Corporate financing and investment decisions when firms have information that investors do not have," Working papers 1523-84., Massachusetts Institute of Technology (MIT), Sloan School of Management.
- Mueller, Dennis C, 1972. "A Life Cycle Theory of the Firm," Journal of Industrial Economics, Wiley Blackwell, vol. 20(3), pages 199-219, July.
- 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(2), pages 137-190.
- 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.
- Easterbrook, Frank H, 1984. "Two Agency-Cost Explanations of Dividends," American Economic Review, American Economic Association, vol. 74(4), pages 650-659, September.
- Jorgenson, Dale W, 1971. "Econometric Studies of Investment Behavior: A Survey," Journal of Economic Literature, American Economic Association, vol. 9(4), pages 1111-1147, December.
- Schiantarelli, F. & Georgoutsos, D., 1990. "Monopolistic competition and the Q theory of investment," European Economic Review, Elsevier, vol. 34(5), pages 1061-1078, July.
- 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.
- Oliner, Stephen D & Rudebusch, Glenn D, 1992. "Sources of the Financing Hierarchy for Business Investment," The Review of Economics and Statistics, MIT Press, vol. 74(4), pages 643-654, November.
When requesting a correction, please mention this item's handle: RePEc:wbk:wbrwps:1663. See general information about how to correct material in RePEc.
For technical questions regarding this item, or to correct its authors, title, abstract, bibliographic or download information, contact: (Roula I. Yazigi)
If references are entirely missing, you can add them using this form.