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A generalized neoclassical model of firm financing and investment. (Research Notes).

This study presents a model that extends Jorgenson's neoclassical model of investment. The firm is assumed to maximize stockholder wealth subject to constraints on the amount of output obtainable from its labor and capital services, the flow of capital services from the firm's capital, and the amount of borrowing possible. The resulting investment and borrowing demand functions each include both physical and financial input variables. These include the value of output, the leverage rate, the excess of the equity yield over the risk-free rate of interest, and a default risk premium.

To test the model, it is assumed that desired investment and desired borrowing can be approximated by linear functions of the variables appearing in the demand equations. Regression equations are estimated using data for domestic investment and borrowing by U.S. non-financial corporations.

The estimates of both the investment and borrowing components of the model generally fit the data quite well. A finding of particular interest is the apparent importance of the leverage rate in determining the level of investment expenditure. One implication of this result is that if a firm's borrowing policies are rigid, an unwillingness to borrow may impair investment. The results also suggest that a firm's real capital requirements have an important effect on its borrowing behavior. (JEL G30)

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Author:Chamberlain, Trevor W.
Publication:International Advances in Economic Research
Date:May 1, 2002
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