Working Paper

Investment behavior, observable expectations, and internal funds

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.

Keywords: Investments; Liquidity (Economics); Econometric models;

Bibliographic Information

Provider: Board of Governors of the Federal Reserve System (U.S.)

Part of Series: Finance and Economics Discussion Series

Publication Date: 1999

Number: 1999-27