pindado 2002 The Under Investment and Over Investment Hypotheses.pdf

7/28/2019 pindado 2002 The Under Investment and Over Investment Hypotheses.pdf

1/24

The underinvestment and overinvestment hypotheses: An

analysis using panel data

Artur MORGADO

Instituto Politcnico de Coimbra (Portugal)

Julio PINDADO

Universidad de Salamanca (Spain)

Address for correspondence:

Julio Pindado

Dpto. de Administracin y Economa de la Empresa

Campus Miguel de Unamuno

Universidad de Salamanca

37007 Salamanca

Telfono: (923) 294400

294640 Ext. 3506

Fax: (923) 294715

E-mail: [email protected]


2/24

2

The underinvestment and overinvestment hypotheses: An analysis

using panel data

ABSTRACT

In this paper we study the relationship between firm value and investment in order to

test the underinvestment and overinvestment hypotheses. The results obtained, using

panel data methodology as the estimation method, indicate that the abovementioned

relation is quadratic, whichimplies that thereexists an optimal level of investment. As a

consequence, firms that invest less than the optimal level suffer from an

underinvestment problem, while those firms that have a level of investment higher than

the optimum suffer from an overinvestment problem. The aforementioned quadratic

relation is maintained when firms are classified depending on their investment

opportunities. Moreover, in accordance with the theory, those firms with valuable

investment opportunities maintain an optimal level of investment higher than that of

those whose investment opportunities are of low quality.

1. INTRODUCTION

In a world of perfect capital markets, Modigliani and Miller (1958) demonstrated that

investment, financing and dividend decisions are independent. During the last decades,


3/24

3

however, the empirical evidence has shown that those decisions are interdependent.

Accordingly, some theories that explain the previous evidence have been developed.

These theories are based on capital-market imperfections; in particular, with respect to

the investment decision, the existence of asymmetric information between the main

stakeholders is the foremost imperfection.

The role of the asymmetry of information in investment decisions has as its

primary basis the theoretical works of Jensen and Meckling (1976), Myers (1977) and

Myers and Majluf (1984). The first two papers emphasize the consequences of the

existence of post-contract asymmetric information between shareholders and

bondholders, while the paper of Myers and Majluf (1984) emphasizes the role of the

pre-contract asymmetric information between current and prospective shareholders. All

the abovementioned papers show that informational asymmetries may lead to some

investment projects with a positive net present value (NPV) not being undertaken. A

second foundation in the study of inefficient investment decisions is the work of Jensen

(1986). This paper, starting from the hypothesis of the existence of asymmetric

information between managers and shareholders, introduces the so-called problem of

overinvestment, as a basic argument of his free cash flow theory. According to this

theory there can be negative NPV investment projects that end up being completed. In this way, whenever an underinvestment process or an overinvestment process

arises the value of the firm will be affected. Thus, it is worthwhile to hypothesize that

the relationship between investment and firm value is not monotonic but rather

increases up to one determined optimal level and decreases after this level. Firms will

first undertake those investment projects with a positive NPV and the firm value will

grow until the positive NPV projects become exhausted. Those firms that continue

investing will undertake negative NPV projects and, hence, their market value will


4/24

4

decrease. In this context, levels lower than the optimum confirm the underinvestment

hypothesis and levels higher than the optimum, the overinvestment hypothesis.

To test the main hypothesis put forward in our paper, that is, that the relationship

between firm value and investment is quadratic rather than linear, we havedeveloped a

model that relates firm value and investment, incorporating a quadratic term of

investment in the equation. The results obtained in the estimation of this model allow us

to conclude that the abovementioned hypothesis is verified. We also study the

relationship between firm value and investment depending on the quality of investment

opportunities. In this case, the results also confirm the previous hypothesis and show

that the optimal level of investment is higher for those firms with valuable investment

opportunities.

The remainder of the paper is organized as follows. Section II describes the

underinvestment and overinvestment hypotheses in orderto develop a model that relates

firm value and investment in Section III. In Section IV we present the database, explain

the estimation method and discuss the results. Finally, our conclusions are presented in

Section V.

2. THE UNDERINVESTMENT AND OVERINVESTMENTHYPOTHESES

In imperfect capital markets, financing and investment decisions are not independent. In

fact, capital-market imperfections, such as informational asymmetries and agency costs,

could lead to either underinvestment or overinvestment processes, that is, not all

positive NPV projects will be undertaken and some negative NPV projects will not be

rejected. Informational asymmetries contribute to several conflicts between the main


5/24

5

stakeholders, which give rise to either overinvestment or underinvestment processes.

Next, we describe these topics and how they are connected, following Figure I.

Given the limited liability of shareholders, they are encouraged to invest in

riskier investment projects than those initially defined in the loan conditions. This is due

to the fact that riskier projects are expected to give larger benefits which will be mainly

enjoyed by the shareholders; whereas if large losses occur, these will be passed on to

the bondholders (Jensen and Meckling, 1976). In this case, the well-known problem of

asset substitution arises. When post-contract asymmetric information exists, and given

the impossibility of developing full contracts, such asymmetry of information could

induce costs for shareholders, since bondholders discount the prospective substitution of

assets. Thus, either the rise in interest rates, credit rationing or the imposition of limiting

conditions in investment or financing terms, may limit the capacity of the shareholders

to develop their investment projects. This problem of asset substitution between

shareholders and bondholders is, therefore, one of the mechanisms that lead to

underinvestment.

The conflict between shareholders and bondholders also gives rise to a problem

of underinvestment by moral hazard. Given the priority of bondholders in case of

bankruptcy, shareholders may find themselves in a situation where bondholders

appropriate part of the value created. Therefore, shareholders will have an incentive to

abandon NPV projects whenever the NPV is lower than the amount of debt issued

(Myers, 1977). Thus, bondholders will try to prevent those suboptimal investment

policies being adopted by using several mechanisms, such as debt covenants, the

reduction of the stated periods of loan, and greater supervision and control. However, all

these procedures only imply a slight mitigation of the problem and, moreover, their cost

is ultimately borne by the shareholders.


6/24

6

Additionally, the conflict between shareholders and bondholders also gives rise

to a problem of underinvestment by adverse selection. This problem arises from the

higher premium required by bondholders, since they do not have enough information to

distinguish the quality of the different investment projects of the firm (Stiglitz and

Weiss, 1981). Thus, if the investment outlay of all positive NPV projects is higher than

the internal funds available, the firm might forgo those investment projects rather than

issue risky debt.

The conflict between current and prospective shareholders may also lead to

underinvestment caused by adverse selection. Myers and Majluf (1984) proved that, due

to pre-contract asymmetric information between prospective and current shareholders in

relation to the investment projects and the assets in place, the firm might forgo positive

NPV projects. Owing to informational asymmetries the prospective shareholders are

unaware of the firm value and raise the price at which they offer funds. With this price

the existing shareholders may lose more if the investment projects are undertaken than

they would if the investment projects are abandoned.

In summary, the conflicts between bondholders and shareholders and the current

and prospective shareholders may lead to underinvestment processes.

Moreover, the overinvestment process arises from the conflict between

managers and shareholders. When informational asymmetries exist, and taking into

account that the mechanisms used to align the interests between shareholders and

managers may not be fully efficient, managers may use the free cash flow to undertake

negative NPV projects in their own best interest (Jensen, 1986). Note that free cash flow

is cash flow in excess of that required to fund all positive NPV projects, hence

managers waste these funds instead of paying them to shareholders. Managers will have


7/24

7

incentives to overinvest because of the pecuniary and non-pecuniary benefits associated

with the larger dimension of the firm (Jensen, 1986; Stulz, 1990).

The empirical evidence on the underinvestment hypothesis was initially

developed through the successive studies on the sensitivity of investment to cash flow,

especially after the methodological innovative study by Fazzari et al. (1988).1 Almost

all these studies 2 find a strong dependence of investment on the availability of internal

funds, this dependence being interpreted as evidence of the underinvestment problem by

adverse selection. However, the positive relationship found between investment and

cash flow may not arise only from the underinvestment problem by adverse selection. It

may also indicate that high levels of cash flow allow managers to undertake negative

NPV projects, which would not happen if they had to raise external funds and explain

the rationality of their investments. The study by Vogt (1994) allows us to distinguish

both effects and obtain empirical evidence of both problems (underinvestment and

overinvestment) depending on the different features of the firms. Thus, the

overinvestment hypothesis is confirmed whenever the positive relationship between

investment and cash flow is maintained for firms whose investment opportunities are of

low quality. On the contrary, for firms with valuable investment opportunities, a

positive relationship indicates an underinvestment problem.

There are also several papers that obtain empirical evidence on each of the

hypotheses using the event study methodology. These studies analyse the reaction of the

market to announcements of investment decisions (see for example Doukas, 1995;

Vogt, 1997; Chen and Ho, 1997) or to announcements of dividend decisions (see for

example Lang and Litzenberger, 1989), distinguishing the firms according to their

investment opportunities and/or free cash flow level. In general, these studies provide

evidence that abnormal returns are larger for the firms with valuable investment


8/24

8

opportunities. However, the evidence on the free cash flow effect is not so clear (see

Chen and Ho, 1997).3

The underinvestment and overinvestment problems have also been studied

through other perspectives. For instance, Lang et al. (1996) obtain favourable evidence

on the overinvestment hypothesis, when finding that high ratios of indebtedness limit

the development of investment projects only for the firms whose investment

opportunities are of low quality. Nohel and Tarhan (1998) also find evidence in

accordance with the free cash flow theory by studying the effect of the reacquisition of

shares on the operational performance of firms. Adedeji (1998) obtains mixed evidence

on the underinvestment hypothesis by studying the simultaneous interrelation between

the investment, financing and dividend decisions. Finally, Miguel and Pindado (2001)

conclude that, in a context of asymmetric information, firms are worried either by the

underinvestment problem or by the overinvestment problem depending on their cash

flow and debt levels, thus corroborating the trade-off between underinvestment and

overinvestment considered by Stulz (1990).

As a consequence of the abovementioned empirical evidence, nowadays there is

a generalized consensus on the distortions that informational asymmetries introduce into

the investment decision. Thus, contrary to the hypothesis of perfect capital markets

maintained by Modigliani and Miller (1958), informational asymmetries could lead to

underinvestment or overinvestment processes. Both problems will affect the firms

value since, on the one hand, positive NPV projects will not be undertaken and, on the

other hand, negative NPV projects will not be rejected. Hence, when a firm becomes

affected by an underinvestment problem, if an additional investment is undertaken the

market value should increase. If the problem is one of overinvestment, any additional

investment must negatively affect the wealth of the shareholders. Assuming as a


9/24

9

reasonable hypothesis that the investment projects of greater NPV will always be

undertaken in first place, even in the managers own best interest (Stulz, 1990), the

market value will increase until a certain investment level is reached. After that

optimum the market value will start to decrease. Therefore, the main hypothesis to

prove in our paper is: the relationship between market value and investment is

quadratic, implyingthat there exists an optimal level. Levels below the optimal one will

confirm the underinvestment hypothesis while higher levels will confirm the

overinvestment one (see Figure II).

3. SPECIFICATION OF THE MODEL

In order to test the hypothesis mentioned in the previous section, we develop a model

that relates the value of the shares of the firm to its main financial decisions, taking into

account the behaviour of the investment variable described above:

(V it /Ki,t-1)=0 + 1(I it /Ki,t-1) + 2(I it /K i,t-1)2 + 3(B it /Ki,t-1)+ 4(D it /Ki,t-1)+ eit

(1)

where Vit is the market value of the shares of firm i at the end of period t, Iit is the

investment undertaken by firm i in period t, Bit is the increment of the market value of

the long-term debt, Dit are the dividends paid in period t, and finally Ki,t-1 is the

replacement value of the assets at the end of period t-1.4

The model defined in equation (1) relates investment and firm value, controlling

the other two main financial decisions of the firm, that is, financing and dividends

decisions, which could affect firm value due to the existence of market imperfections.

The expected relationship between increment of debt and firm value is positive, since,


10/24

10

whenever the bankruptcy probability is not very high, an increment of debt will have a

positive effect on the wealth of the shareholders because new debt means obtaining new

tax-shields. The expected relationship between dividends and firm value is also positive,

because in addition to the possible effects in relation to the imperfections, dividends are

a source of value creation for the shareholders of the firm. Note that the well-known

capital-market arbitrage condition stipulates that the net after-tax return for shareholders

may be obtained in two ways: from capital appreciation and from current dividends (see

Whited, 1992; Blundell et al., 1992).

As we have commented in the previous section, the overinvestment and

underinvestment processes are not exclusive and must affect the market value of the

firm. Thus, if a firm is facing by an underinvestment problem, a marginal increase in

investment must positively affect the market value of the shares, while the effect will be

negative if the problem is one of overinvestment. Therefore, an optimal level of

investment will exist, which is reflected in the model since weincorporated in equation

(1) the investment variable and its square.

Consequently, if, after estimating the model, we differentiate the firm value

variable with respect to the investment variable, we would obtain:

+=

1

21

1

12

it

it

it

it

it

it

K

I

K

I

K

V

(2)

then, making the first derivative equal to 0 and solving for the investment variable, we

obtain:

2

1

1 2

=

it

it

K

I(3)


11/24

11

Finally, if the second partial derivative of the firm value variable with respect to

the investment variable is negative, the value obtained from equation (3) will be a

maximum.

2

1

2

1

2

2=

it

it

it

it

K

I

K

V

(4)

Accordingly, in order to obtain a maximum from equation (3), 2 should be

negative. Also, for the optimal level of the investment determined in equation (3) to be

positive, 1 should be positive. Consequently, if the signs of these coefficients hold

when equation (1) is estimated our main hypothesis will be proved.

If the previous hypothesis is verified, we can also, in agreement with the theory,

put forward an additional hypothesis: that the optimal level of investment will be

different depending on the quality of investment opportunities. To be exact, the

abovementioned optimal level will have to be higher for those firms that have valuable

investment opportunities. In order to test this hypothesis, we define a dummy variable

for each firm, DQi, which is equal to 1 for those firms that during the period have an

average Tobins q less than one, and 0 otherwise. Thus, we extended the specification of

the model in equation (1) by incorporating a dummy variable that interacts with the linear

and quadratic terms of the investment variable. This dummy variable represents the

quality of investment opportunities. Therefore, the new model would be as follows:

(V it /Ki,t-1) = 0 + (1 + 1DQ i) (I it /Ki,t-1) + (2+ 2DQ i) (I it /Ki,t-1)2 + 3(B it /Ki,t-1)+

4 (Dit/Ki,t-1) + eit (5)

Thus, we classify the firms in two groups: when Tobins q is less than 1, firms

are classified as non-valuable project firms (hereafter, NVP firms), otherwise they are

classified as valuable project firms (hereafter, VP firms). In this new model, 1 and 2


12/24

12

are the coefficients that define the optimal level of investment for VP firms, since for

those firms DQi is equal to 0. Hence, the optimal level for VP firms will be obtained

using equation (3). However, for NVP firms DQi takes the value of 1, therefore the

optimal level will be obtained through the following equivalent equation:

( )22

11

1 2

++

=

it

it

K

I(6)

Based on this new model, as it appears in Figure III, we therefore put forward

the following additional hypothesis: the optimal level of investment for VP firms,

(Iit/Ki,t-1)q>1

, will be higher than the optimal level of investment for NVP firms, (Iit/Ki,t-

1)q


13/24


14/24

14

an individual effect, i. Hence, we took first differences of the variables in order to

eliminate the individual effect. We also included the dummy variables dt to measure the

time effect, so as to control the effect of macroeconomic variables on firm value.

Consequently, we split the error term into three components: the individual effect, i,

the time effect, dt, and, finally, the random disturbance, it. As a result, the final

specification of the models to estimate is as follows:

(Vit /Ki,t-1) = 0 + 1(I it /Ki,t-1) + 2(I it /Ki,t-1)2 + 3(B it /Ki,t-1)+ 4(D it /Ki,t-1)+ dt +

i + it (7)

(Vit /Ki,t-1)=0 + (1 + 1DQ i) (I it /Ki,t-1) + (2+ 2DQ i) (I it /Ki,t-1)2

+ 3(B it /Ki,t-1)+

4 (Dit/Ki,t-1) + dt + i + it (8)

The estimation was carried out using DPD98 for GAUSS written by Arellano

and Bond (1998). In order to check for potential mis-specification of the models we use

the Sargan statistic of over-identifying restrictions, which tests for the absence of

correlation between the instruments and the error term. Another specification test used

is the m2 statistic, developed by Arellano and Bond (1991), to test for lack of second-

order serial correlation in the first-difference residuals. Finally, besides the

aforementioned specification tests, Table 4 provides two Wald tests: the first (z1) is a

test of the joint significance of the reported coefficients, while the second (z2) is a test of

the joint significance of the time dummies. As can be seen in Table 4, our models pass

all the abovementioned tests.

4.3 RESULTS

The results obtained verify our main hypothesis. As can be seen in column I of Table 4,

1 is positive and 2 is negative, both coefficients being significant. These results

indicate that the relationship between investment and firm value is quadratic rather than


15/24

15

linear. That is, a marginal increase in investment has a positive effect on the wealth of

shareholders whenever the optimal investment level has not yet been exceeded. This

level reflects the beginning of the exhaustion of positive NPV projects.

According to the results shown in column I of Table 4 and substituting the

values obtained for the coefficients 1 and 2 into equation (3), we find that the optimal

level of investment is 0.4558. This implies that, in general terms, firms keep investing

in positive NPV projects until this level is reached, and hence the value of their shares

keeps rising. However, once this optimal level has been reached firms undertake

negative NPV projects and, thus, the value of their shares decreases. In this way, the

results obtained confirm both the underinvestment and the overinvestment hypotheses.

The former for those firms whose level of investment is lower than the optimum,

therefore located in Figure II to the left of (Iit/Ki,t-1)*. The latter for those firms whose

investment level is located to the right of (Iit/Ki,t-1)*.

The fact that the investment level is located to the left of the optimumindicates

that the firms suffer from financial constraints which do not allow them to undertake all

the positive NPV projects at any time. Therefore, these firms are facing an

underinvestment process. The financial constraints suffered by those firms are due to

the higher premium required by bondholders or prospective shareholders. This higher

premium is due to either the conflict between shareholders and bondholders or the

conflict between current and prospective shareholders. On the contrary, when the firms

investment level is located to the right of the optimum, this indicates that the firms are

undertaking negative NPV projects. These negative NPV investments do not increase

the wealth of shareholders. Hence, they are only undertaken to maximize the objective

function of the managers, and so firms are in the face of an overinvestment process. The

overinvestment process arises when managers waste free cash flow instead of paying


16/24

16

these funds to shareholders; this behaviour is caused by the conflict between

shareholders and managers.

All the other variables in the model also show significant coefficients. The

increment of debt variable has a positive coefficient, due to the new tax-shields

obtained. The coefficient for the dividends variable is also positive. This latter result

indicates that the dividends paid in the period are one of the sources of value creation

for shareholders, as stipulated in the capital-market arbitrage condition.

Column II of Table 4 provides the results of the estimation of model II,

developed to study the relationship between firm value and investment depending on

the quality of investment opportunities. Before discussing these results let us point out

that 1 and 2 are, respectively, the coefficients for the investment and the square

investment variables for VP firms, while in the case of NVP firms the coefficients for

the abovementioned variables are (1+1) and (2 +2). Therefore, as 1 is positive and

2 is negative, we can affirm that the relationship between firm value and investment is

quadratic for VP firms. However, before interpreting the coefficients for NVP firms, we

must perform two linear restriction tests in order to check whether these coefficients are

significantly different from zero. As Table 4 shows, the null hypothesis H0: 1+1 = 0 is

rejected, since the t1 statistic takes the value of 32.3175, and the null hypothesis H0: 2

+2= 0 can also be rejected, since the t2 statistic takes the value of 35.4839. Therefore,

both (1+1)=0.3869 and (2 +2)=0.6867 are significantly different from zero, and their

signs allow us to confirm the previous quadratic relationship also for NVP firms.

Furthermore, by substituting the values obtained for 1 and 2 in equation (3), we find

that the optimal level of investment for VP firms is 0.7774. The optimal level of

investment for NVP firms is 0.2837, as can be verified by substituting (1+1) and (2


17/24

17

+2) in equation (6). These results support the relationship between investment and firm

value posed in model I, where the optimal level of investment obtained for the whole

sample of firms is 0.4558. Thus, in agreement with our second hypothesis, the following

is verified: (Iit/Ki,t-1)q1. Finally, in model II, the significance

and sign of the other variables remain, thus confirming the results obtained in model I.

5. CONCLUSIONS

This paper tests the following main hypothesis: the relationship between firm value and

investment is quadratic, which implies that an optimal level of investment exists; levels

lower than the optimum confirm the underinvestment hypothesis and higher levels the

overinvestment one.

The results obtained allow us to conclude that the abovementioned hypothesis is

fulfilled. In fact, there exists an optimal level of investment, which is the level where the

positive NPV projects are exhausted. Therefore, firms that exceed that value find

themselves in an overinvestment process, created by the divergence of interests between

shareholders and managers and facilitated by the existence of asymmetric information.

In contrast, firms that do not reach that value find themselves in an underinvestment

process, which implies that the existence of asymmetric information increases the price

of the external financial resources, hence the firms forgo positive NPV projects. In this

case, the underinvestment process is also facilitated by the existence of asymmetric

information but it arises from the conflict between shareholders and bondholders and

the conflict between current and prospective shareholders.


18/24

18

Finally, our study also allows us to conclude that firms with valuable investment

opportunities can undertake larger investments until reaching the optimal level, whereas

firms without valuable investment opportunities have an optimal level of investment far

below that of the previous ones, which confirms an exhaustion of their positive NPV

projects.

.

REFERENCES

Adedeji, A. (1998) Does the pecking order hypothesis explain the dividend payout ratios of firms inthe UK?,Journal of Business Finance & Accounting, 25, 1127-55.

Arellano, M. and Bond, S. (1991) Some Tests of Specification for Panel Data: Monte Carlo

Evidence and an Application to Employment Equations, Review of Economic Studies, 58,

277-97.

Arellano, M. and Bond, S. (1998) Dynamic Panel Data Estimation Using DPD98 for GAUSS: A

Guide for Users, Institute for Fiscal Studies, London.

Blundell, R., Bond, S., Devereux, M. and Schiantarelli, F. (1992) Investment and Tobins Q:

Evidence from Company Panel Data,Journal of Econometrics, 51, 233-57.

Chen, S. and Ho, K. (1997) Market Response to Product-Strategy and Capital-Expenditure

Announcements in Singapore: Investment Opportunities and Free Cash Flow, Financial

Management, 26, 82-8.

Cleary, S. (1999) The Relationship Between Firm Investment and Financial Status, The Journal

of Finance, 54, 673-92.

Del Brio, E., Perote, J. and Pindado, J. (2000) Measuring the Impact of Corporate Investment

Announcements on Share Prices, SSRN Working PaperN. 234578.

Doukas, J. (1995) Overinvestment, Tobins q and Gains from Foreign Acquisitions, Journal of

Banking and Finance, 19, 1285-303.

Fazzari, S., Hubbard, R. and Petersen, B. (1988) Financing Constraints and Corporate Investment,

Brooking Papers on Economic Activity, 1, 141-95.

Hubbard, R. (1998) Capital-Market Imperfections and Investment,Journal of Economic Literature,

36, 193-225.

Jensen, M. and Meckling, W. (1976) Theory of the Firm: Managerial Behavior, Agency Cost

and Ownership Structure,Journal of Financial Economics, 3, 305-60.


19/24

19

Jensen, M. (1986) Agency Costs of Free Cash Flow: Corporate Finance and Takeovers,

American Economic Review, 76, 323-9.

Kaplan, S. and Zingales, L. (1995) Do Financing Constraints Explain Why Investment Is

Correlated With Cash Flow?,NBER Working Paper N. 5267.

Lang, L. and Litzenberger, R. (1989) Dividend Announcements. Cash Flow Signalling vs. Free

Cash Flow Hypothesis?,Journal of Financial Economics, 24, 181-91.

Lang, L., Ofek, E. and Stulz, R. (1996) Leverage, Investment and Firm Growth, Journal of

Financial Economics, 40, 3-29.

Lewellen, W. and Badrinath, S. (1997) On the measurement of Tobin's q, Journal of Financial

Economics, 44, 77-122.

Miguel, A. and Pindado, J. (2001) Determinants of Capital Structure: New Evidence from

Spanish Panel Data,Journal of Corporate Finance, 7, 77-99.

Modigliani, F. and Miller, M. (1958) The Cost of Capital, Corporation Finance and the Theory

of Investment,American Economic Review, 48, 261-97.

Moulton, B. (1986) Random Group Effects and the Precision of Regression Estimates, Journal

of Econometrics, 32, 385-97.

Moulton, B. (1987) Diagnostics for Group Effects in Regression Analysis, Journal of Business

and Economic Statistics, 5, 275-82.

Myers, S. (1977) Determinants of Corporate Borrowing, Journal of Financial Economics, 5,

147-76.

Myers, S. and Majluf, N. (1984) Corporate Financing and Investment Decisions When Firms

Have Information that Investors Do Not Have, Journal of Financial Economics, 13, 187-

221.

Nohel, T. and Tarhan, V. (1998) Shares Repurchases and Firm Performance: New Evidence on

the Agency Costs of Free Cash Flow,Journal of Financial Economics, 49, 187-222.

Perfect, S. and Wiles, K. (1994) Alternative Constructions of Tobin's q: An empirical comparison,

Journal of Empirical Finance, 1, 313-41.

Stiglitz, J. and Weiss, A. (1981) Credit Rationing in Markets with Imperfect Information,American Economic Review, 71, 393-410.

Stulz, R. (1990) Managerial Discretion and Optimal Financing Policies, Journal of Financial

Economics, 26, 3-27.

Vogt, S. (1994) The Cash Flow/Investment Relationship: Evidence from U.S. Manufacturing

Firms,Financial Management, 23, 3-20.

Vogt, S. (1997) Cash Flow and Capital Spending: Evidence from Capital Expenditure

Announcements,Financial Management, 26, 44-57.


20/24

20

Whited, T. (1992) Debt, Liquidity Constraints and Corporate Investment: Evidence from Panel

Data, The Journal of Finance, 47, 1425-60.

FOOTNOTES1

Hubbard (1998) offers an excellent review of those studies.

2The exceptions are the studies by Kaplan and Zingales (1997) and Cleary (1999).

3See Del Brio et al. (2000) for a more complete overview and additional evidence.

4A more detailed definition of the variables can be found in the appendix.


21/24

21

TABLE 1

STRUCTURE OF THE SAMPLE

Number of annual observationsper company Number ofcompanies Number ofobservations

10 76 760

9 22 198

8 24 192

7 5 35

6 8 48

Total 135 1,233

TABLE 2SAMPLE DISTRIBUTION BY SUB-SECTOR CLASSIFICATION

Sub-sectors Number of

companies

% of

companies

Energy 14 10.37

Extractive Industry 3 2.22

Transport Industry 14 10.37

Textile Industry 3 2.22

Building 22 16.30

Trade and Services 35 25.93

Food Industry 21 15.56Metal Industry 8 5.93

Chemical Industry 9 6.67

Paper Industry 6 4.44

TABLE 3

SUMMARY STATISTIC

Mean Standard

deviation

Minimum Maximum

(V it /Ki,t-1) 0.8869 1.2857 0.0061 21.2218

(I it /Ki,t-1) 0.0609 0.2686 -0.8204 3.8364

(I it /Ki,t-1)2 0.0758 0.6967 0.0000 14.7181

(B it /Ki,t-1) 0.0175 0.1977 -1.1657 4.6467

(D it /Ki,t-1) 0.0184 0.0305 0.0000 0.4075


22/24

22

TABLE 4

ESTIMATION

Model I: (V it /Ki,t-1) =0 + 1(I it /Ki,t-1) + 2(I it /Ki,t-1)2 + 3(B it /Ki,t-1)+ 4(D it /Ki,t-1)+ dt + i + it

Model II: (V it /Ki,t-1) = 0 + (1 + 1DQ i) (I it /Ki,t-1) + (2+ 2DQ i) (I it /Ki,t-1)2 + 3(B it /Ki,t-1)+

4(D it /Ki,t-1)+ dt + i + it

Number of companies = 135; Number of observations = 1.098

I II

Constant -0.11082* (0.0141) -0.11617* (0.0098)

(I it /Ki,t-1) 0.44016* (0.0150) 0.48305* (0.0095)

(I it /Ki,t-1)2 -0.48281* (0.0066) -0.31069* (0.0036)

(B it /Ki,t-1) 1.73516* (0.0542) 1.28198* (0.0285)

(D it /Ki,t-1) 15.56776* (0.2533) 17.06528* (0.1878)

DQi*(I it /Ki,t-1) -0.09344* (0.0156)

DQi*(I it /Ki,t-1)2 -0.37605* (0.0189)

z1 14475 (4) 22787 (6)

z2 21286 (8) 100034 (8)

m2 -1.548 -1.580

Sargan 118.49 (108) 125.80 (132)Notes:i) Heteroskedasticity consistent standard asymptotic error in parentheses.ii) * indicates significance at the 1% level.

iii) z1 is a Wald test of the joint significance of the reported coefficients, asymptotically distributed as2under the null of no relationship; z2 is a Wald test of the joint significance of the time dummies; degreesof freedom in parentheses.iv) m2 is a serial correlation test of second order using residuals in first differences asymptoticallydistributed as N(0,1) under the null of no serial correlation.

v) Sargan is a test of over-identifying restrictions, asymptotically distributed as 2 under the null;degrees of freedom in parentheses.


23/24


24/24

Figure II

(Vit/Ki,t-1)

(Iit/Ki,t-1)

Figure III

(Vit/Ki,t-1)

(Iit/Ki,t-1)

Underinvestment (Iit/Ki,t-1) Overinvestment

(Iit/Ki,t-1)q< (Iit/Ki,t-1)

q>

Documents

pindado 2002 The Under Investment and Over Investment Hypotheses.pdf