Investment and cash flow: Asymmetric information or managerial discretion

Kathuria, Rajat; Mueller, Dennis C.

doi:10.1007/bf01384151

Cited by 33 publications

(20 citation statements)

References 23 publications

Supporting

Mentioning

Contrasting

Order By: Relevance

“…Only Kathuria and Mueller (1995) have estimated a marginal q and used it to separate firms into different subsamples as we do. Third, to use qa not as a control for investment opportunities as in other studies but as a measure of the cost of external finance for firms potentially subject to cash flow constraints and as a measure of the tightness of the takeover constraint for firms potentially suffering from agency problems.…”

Section: Tobin's Q Also Figures In Our Tests Of the MD Hypothesis Thmentioning

confidence: 99%

“…Kathuria and Mueller (1995) where I, and R, are capital investment and R&D in year t. These equations resemble the reduced-form equations that have been used to test either the AI or the MD hypotheses in other studies. Kathuria and Mueller (1995) where I, and R, are capital investment and R&D in year t. These equations resemble the reduced-form equations that have been used to test either the AI or the MD hypotheses in other studies.…”

Section: Summary Of Hypothesesmentioning

confidence: 99%

See 1 more Smart Citation

Marginal q, Tobin's q, Cash Flow, and Investment

Gugler¹,

Mueller²,

Yurtoğlu³

2004

Southern Economic Journal

Self Cite

View full text Add to dashboard Cite

JSTOR is a not-for-profit service that helps scholars, researchers, and students discover, use, and build upon a wide range of content in a trusted digital archive. We use information technology and tools to increase productivity and facilitate new forms of scholarship. For more information about JSTOR, please contact support@jstor.org. This content downloaded from 155.69.Many studies of the determinants of investment use Tobin's q to control for the investment opportunities of a firm. Tobin's q roughly measures the average return on a firm's capital anticipated by the market. More relevant for investment decisions, however, is the marginal return on capital. In this paper we estimate investment and research and development (R&D) equations using a measure of marginal q. We use marginal q to identify the existence of cash constraints and managerial discretion and as a separate explanatory variable. For a sample of 560 U.S. firms observed over the 1977-1996 period we present evidence confirming the existence of both cash constraints in some companies and managerial discretion in others. (1957) is the pioneering study. Chirinko (1993) presents a comprehensive survey of the investment determinants literature. 2 The transaction costs hypothesis was first developed by Duesenberry (1958). Grabowski and Mueller (1972) were the first to hypothesize that the cash flow/investment relationship was caused by agency problems. The first empirical test of the asymmetric information hypothesis was by Fazzari, Hubbard, and Petersen (1988). 3 See Stiglitz and Weiss (1981) and Myers and Majluf (1984). 512 This content downloaded from 155.69.24.171 on Mon, 01 Jun 2015 08:53:04 UTC All use subject to JSTOR Terms and Conditions Marginal q, Cash Flow, and Investment 513 do so? Previous studies have used size, level of dividends, age, concentration of share ownership, and extent of cross-shareholdings to identify firms that are possibly subject to Al problems.4 Although the capital market may have difficulty judging the investment opportunities of small firms, this in itself need not imply that the firm has attractive investment opportunities or that its cash flows are Meyer and Kuhinadequate to finance them, if it does. Similar criticisms can be lodged against the other characteristics used to identify firms subject to Al problems.5 One of this article's contributions is to use a characteristic of firms that better identifies whether they suffer from Al problems. The Al hypothesis assumes that the firm's managers seek to maximize their shareholders' wealth but are prevented by a shortage of cash from undertaking investments with expected returns above the firm's cost of capital. Any firm caught in this predicament should, therefore, have a return on its investment, r, that is greater than its cost of capital, i. Our procedure for identifying firms subject to such cash constraints is thus to estimate the ratio r/i for each firm over our sample period and to categorize any firm for which this r/i > 1 as possibly cash constrained.6The agen...

show abstract

Section: Tobin's Q Also Figures In Our Tests Of the MD Hypothesis Thmentioning

confidence: 99%

Section: Summary Of Hypothesesmentioning

confidence: 99%

Marginal q, Tobin's q, Cash Flow, and Investment

Gugler¹,

Mueller²,

Yurtoğlu³

2004

Southern Economic Journal

Self Cite

View full text Add to dashboard Cite

show abstract

“…Maximising U with respect to I yields a first order condition that ensures, under fairly unrestrictive conditions, that the marginal product of capital for the firm lies below the discount rate, indicating managerial caution or constraint (Kathuria and Mueller 1995).…”

mentioning

confidence: 99%

Why do hurdle rates differ from the cost of capital?

Driver¹,

Temple²

2009

Cambridge Journal of Economics

View full text Add to dashboard Cite

Analysing a sample of business units from the PIMS data bank of North American companies we are able to extract data on investment hurdle rates, thus accessing a variable that is rarely observable. The text-book story maintains that firms should invest only if the return exceeds the cost of funds. Several theories however, explain the use of investment hurdle rates that differ from discount rates. We find that hurdle rates are frequently below and also frequently above matched data on discount rates. In a statistical analysis we find that this behaviour can be explained by a combination of agency theory and real options theory. We take this as important evidence that a full explanation of capital investment cannot be accomplished without a consideration of behavioural and strategic influences.

show abstract

“…In this case, additional cash flow leads to additional investment, but for a reason much different than when the firm faces finance constraints. In terms of the labels used by Kathuria and Mueller (1995), we need to test the asymmetric information hypothesis (AIH) versus the managerial discretion hypothesis (MDH). The differences underlying the fundamental correlation are clearly important for understanding firm behaviour.…”

Section: Comment To "Corporate Investment Asymmetric Information Andmentioning

confidence: 99%

Comment to “Corporate Investment, Asymmetric Information and Agency Costs in the UK”

Chirinko¹

2001

VJH

View full text Add to dashboard Cite

Recent studies of business investment (Fazzari, Hubbard, Petersen, 1988), as well as much earlier work (e.g., Tinbergen, 1939;Klein, 1951), have established that investment spending and cash flow are strongly positively correlated. Professors Goergen and Renneboog set for themselves the ambitious task of uncovering the meaning of this fundamental correlation. One interpretation is that it reflects the finance constraints due to asymmetric information between the firm and providers of external finance. An increase in cash flow relaxes finance constraints, thus allowing the firm to undertake more investment. An equally compelling alternative is that managers have a substantial amount of discretion, and undertake actions, such as investment in projects with relatively poor returns, that favor their interests over those of the owners. In this case, additional cash flow leads to additional investment, but for a reason much different than when the firm faces finance constraints. In terms of the labels used by Kathuria and Mueller (1995), we need to test the asymmetric information hypothesis (AIH) versus the managerial discretion hypothesis (MDH). The differences underlying the fundamental correlation are clearly important for understanding firm behaviour. This paper contains three important innovations. First, it joins a small but growing literature that examines both the AIH and MDH hypothesis together. These problems have analyzed in two extensive but largely independent empirical literatures. For example, the recent comprehensive surveys of finance constraints (Hubbard, 1998) and corporate governance (Shleifer, Vishny, 1997) make little mention of the work cited in the other survey. Of the 101 references in the former study and 237 references in the latter, only seven are common to both. This tiny overlap is surprising since both derive from the same basic problem, the uneven distribution of information between firm and participants in external capital markets.Second, the paper uses several detailed measures of ownership concentration. Unlike data from financial statements, this information can not be obtained from computer-accessible files. Rather, one needs to do the careful and painstaking work of reading through annual reports and collecting the information in a form suitable to address the questions at hand.Third, the paper employs a systems GMM estimator. This econometric technique estimates the equation of * Emory University and CESifo. interest in levels with the instrumental variables differenced and with the equation of interest in differences with the instruments in levels. While the estimator is fairly new (Blundell, Bond, 1998), it seems to overcome some problems with the traditional GMM estimator.Given the impressive data and powerful econometric technique, this paper is well-positioned to generate important insights into the relations between the AIH and MDH hypotheses and the fundamental correlation. An Euler equation is chosen as the estimating equation. Although I am persuaded about the importance...

show abstract

Investment and cash flow: Asymmetric information or managerial discretion

Cited by 33 publications

References 23 publications

Marginal q, Tobin's q, Cash Flow, and Investment

Marginal q, Tobin's q, Cash Flow, and Investment

Why do hurdle rates differ from the cost of capital?

Comment to “Corporate Investment, Asymmetric Information and Agency Costs in the UK”

Contact Info

Product

Resources

About