Premium
Connecting Optimal Capital Investment and Equity Returns
Author(s) -
Porter R. Burt
Publication year - 2005
Publication title -
financial management
Language(s) - English
Resource type - Journals
SCImago Journal Rank - 1.647
H-Index - 68
eISSN - 1755-053X
pISSN - 0046-3892
DOI - 10.1111/j.1755-053x.2005.tb00100.x
Subject(s) - economics , profitability index , equity (law) , investment (military) , equity risk , monetary economics , lag , equity capital markets , econometrics , financial economics , return on investment , equity ratio , investment strategy , production (economics) , return on equity , finance , microeconomics , private equity , market liquidity , computer network , politics , political science , computer science , law
Economic theory predicts a contemporaneous correlation between equity returns and investment growth that is only weakly present in the data. By modifying the firm's production function to include a lag between investment decisions and expenditures, and after correcting for the temporal aggregation of investment, I find the predicted correlation to be present in the data. I estimate the model for 31 industries and find that investment returns are highly correlated with the industry portfolio equity returns. Further, the portion of investment returns orthogonal to equity returns is associated positively with changes in profitability and negatively with lagged differences between equity and investment returns.