Finance and Economics Discussion Series (FEDS)
June 1999
Investment Behavior, Observable Expectations, and Internal Funds
Jason G. Cummins, Kevin A. Hassett, and Stephen D. Oliner
Abstract:
We use earnings forecasts from securities analysts to construct more accurate measures of the fundamentals that affect the expected returns to investment. We find that investment responds significantly -- in both economic and statistical terms -- to our new measures of fundamentals. Our estimates imply that the elasticity of the investment-capital ratio with respect to a change in fundamentals is generally greater than unity. In addition, we find that internal funds are uncorrelated with investment spending, even for selected subsamples of firms -- those paying no dividends and those without bond ratings -- that have been found to be "liquidity constrained" in previous studies. Our results cast doubt on the evidence for liquidity constraints from the many studies that have used Tobin's Q to control for the expected returns to investment.
Full paper (761 KB Postscript)Keywords: Investment, Tobin's Q, cash flow, liquidity constraints
PDF: Full Paper
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