Financial factors in the investment decisions of firms : theory and evidence
This thesis examines the effects of informational imperfections in the financial system on the investment decisions of firms. Its main theme is that such imperfections are relevant for the dynamic aspects of investment decision making, for they affect the cost of flow of new financing. Since their source is ultimately the decentralized nature of the system, where some of the creditors of the firm have not access to the firm' s internal operations, the costs involved are likely to arise in every type of financial market and in the use of every kind of financial instrument. The only source of funds not affected by the informational problems is the flow of internal financing, but this is either constrained or involves rising costs for the insiders. Therefore, there are costs of adjustment in capital accumulation that are related to the financial arrangements of the system. A dynamic optimization model is built to examine the combined financial and investment decisions of a firm operating in an asymmetric information environment. The resulting policies are compared with those of a firm facing conventional adjustment costs and a strongly efficient financial system. The importance of internal financing is confirmed. The role and problems of the equity market as a source of finance is also illuminated. Equity finance is found to differ from debt in so far as equity claims give the right of access to the internal operations of the firm. A model with both types of adjustment costs is also examined. When conventional adjustment costs are dismantling costs (when investment is negative), asymmetries arise between under- and over-leveraged firms with possible implications for policy. Also, Tobin's Q investment approach is re-examined in a model with both type of costs. The Q variable is found to contain interesting information even when capital markets are not strongly efficient. An empirical model is built after examining the behaviour of firms in output markets when facing a stochastic demand. The model is tested with panel industry level data from Greece for the manufacturing sector in 1973-1983. An error correction specification is used. The results confirm the importance of the impact effect of net profitability. Demand and the associated capacity utilization are also found to have a significant effect in the short and in the long run. The evidence is less clear for the user cost of capital and the gross profit margin.