Two Essays on Investment and Financing Decisions of Firms
Rahman, Shafiqur
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https://hdl.handle.net/2142/71523
Description
Title
Two Essays on Investment and Financing Decisions of Firms
Author(s)
Rahman, Shafiqur
Issue Date
1986
Department of Study
Finance
Discipline
Finance
Degree Granting Institution
University of Illinois at Urbana-Champaign
Degree Name
Ph.D.
Degree Level
Dissertation
Keyword(s)
Economics, Finance
Abstract
Essay I examines the intertemporal interdependencies among investment, financing, and dividend decisions of a present-value maximizing firm. The approach taken is that of control theory. The model provides useful insight into optimum firm behavior over time. The results show that investment and financing decisions are jointly determined for a value maximizing firm. This is an argument against the separation principle. The second important result is that dividend policy does generally affect the maximizing firm's value. This result invalidates the residual theory of dividends. The model prescribes an optimal investment-financing plan, the long-run equity and debt demand for the firm, and the long-run behavior of investment and financing as they are affected by the existence of adjustment costs.
In essay II the intertemporal interactions and interdependencies among investment, financing, and dividend decisions are analyzed in the context of a financial planning model. The main issue addressed is how do financial managers incorporate these interactions into the planning process. We investigated the theoretical and empirical evidence relating to joint determination of important decisions of a firm. Theoretical works reviewed showed that firm's real (production and investment) decisions are linked with financial (capital structure and dividend) decisions. Empirical works surveyed showed the relationships among firm's investment, financing, and dividend decisions. Next, various financial planning models are critiqued. To capture the interactions of firm's investment, financing, and dividend decisions, a simultaneous equation financial planning model is proposed in this essay. The model specifies behavioral equations for sales, production, investment, cost structure, dividends, and external financing. It also includes several definitional equations to capture various accounting relationships and valuation concepts. The model was fit to the data of a sample of firms. The results of our empirical tests indicated that there is interaction among the important decision variables of a firm. The model was also used for ex-post forecasting. In general, the model predictions obtained compares relatively well with the naive autoregressive model. The essay also proposes a financial planning model that uses optimal control theory to achieve optimization.
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