Value maximization and the information content of corporate investment with respect to earnings

In this paper we study the dynamic nature of the relationship between earnings and investment. If managers act as wealth maximizers, we would expect that new investments should lead to increased earnings. However, past research has found that investment is not causally prior to earnings. Using recen...

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Bibliographic Details
Published in:Journal of banking & finance 1997-05, Vol.21 (5), p.661-683
Main Authors: Bong-Soo Lee, Nohel, Tom
Format: Article
Language:English
Subjects:
Banking
Capital investments
Causality
Causality/cointegration
Corporate finance
Earnings
Econometrics
Enterprises
Finance
Financial management
Information content
Investment
Investment/earings
Managers
Net present value
Studies
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Summary:In this paper we study the dynamic nature of the relationship between earnings and investment. If managers act as wealth maximizers, we would expect that new investments should lead to increased earnings. However, past research has found that investment is not causally prior to earnings. Using recent developments in time-series econometrics, we show that the dynamic nature of the relationship between earnings and investment exhibits bi-directional causality. Our results are consistent with managers investing in positive NPV projects, but managers appear to face financing constraints because investment decisions are driven by the availability of internally generated earnings.
ISSN:0378-4266
1872-6372
DOI:10.1016/S0378-4266(96)00063-5