Connecting Optimal Capital Investment and Equity Returns

36 Pages Posted: 13 Oct 2005

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Abstract

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.

Suggested Citation

Porter, R. Burt, Connecting Optimal Capital Investment and Equity Returns. Financial Management, Vol. 34, No. 2, Summer 2005, Available at SSRN: https://ssrn.com/abstract=809964

R. Burt Porter (Contact Author)

Iowa State University ( email )

College of Business
3345 Gerdin Business Bldg
Ames, IA 50011-2063
United States
515-294-2612 (Phone)

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