Investment, alternative measures of fundamentals and revenue indicators

Abstract

The paper investigates the empirical significance of revenue management in determining firm-level fixed capital investment when investment opportunities are controlled for by two of the recently-introduced empirical fundamentals: profitability shocks and the gap measure between the desired and actual capital stocks (mandated investment rate). Tobin's q is also included in the analyses for the purpose of comparison. The data set, which is constructed from the COMPUSTAT database, includes U.S. based manufacturing firms. The results show that financial variables are important determinants of investment but they are not as significant as claimed by some empirical studies focusing on capital market imperfections. The explanatory power of financial variables in the investment process declines with increasing significance of fundamentals. Another interesting result is that the level of investment by expected-to-be financially constrained firms, identified by commonly used a priori measures of financial constraints, tends to be relatively less sensitive to changes in financial variables compared to changes in fundamentals even though the opposite is predicted in the literature. This result questions whether investment-cash flow sensitivity can be a good measure of financial constraints, as well as whether some of the firm characteristics used in identifying financially constrained firms in the literature are sufficient.