ESSAYS ON CORPORATE FINANCING BEHAVIOR (INVESTMENT, DEBT, EARNINGS)

The dissertation consists of three essays. The first essay attempts to confirm the hypothesis that financial factors matter by re-examining the empirical interdependence between financing and investment decisions. The re-examination involves estimating the effect of financial factors, in particular, cash flow on investment expenditure. I use the Tobin's Q investment framework to estimate the importance of cash flow in the investment process. The goal is to find the best possible technique that would minimize the errors-in-variables and endogeneity problems associated with estimating the cash-investment correlation. I find that using a measure of the firm's market power can improve the proxy for the marginal Q, and thus can minimize the errors-in-variables problems.; The second essay attempts to distinguish the imperfect capital market interpretation from the agency interpretation for the strong positive correlation between corporate investment and cash flow. The approach is to take advantage of the prediction that is unique to each interpretation. The imperfect capital market interpretation predicts that firms with a high cash-investment correlation underinvest because of financial constraints. The agency interpretation predicts that firms with a high cash-investment correlation over-invest because managers are following suboptimal investment rules for private benefits. I use the stock market's reaction to the firm's M&A announcements during 1987-1993 to determine its type. I find that the cash-investment correlation exists for both underinvesting and overinvesting firms. This finding suggests that both interpretations can be valid. This conclusion is fortified as I look at the correlation across managerial ownership. For overinvesting firms, this correlation is a negative function of managerial ownership, whereas for underinvesting firm, it is uncorrelated to managerial ownership.; The third essay provides supporting evidence for the hypothesis that bankruptcy costs, which include direct costs and indirect costs, such as opportunity costs of financial distress, and agency costs between bondholders and shareholders, are very important in the capital structure decision. The empirical strategy of the paper is to demonstrate that when bankruptcy costs are high, leverage tends to be low, and the kinds of debt that are issued have features that would mitigate these bankruptcy costs. This implies that proxies for high bankruptcy costs, such as R&D expenditure, income volatility, should be negatively correlated to leverage, but positively correlated with the amount of convertible debt or lease obligations. The results obtained from using data on manufacturing firms during the time period from 1974-1993 confirm the hypothesis.; The results from these studies suggest that it may be too hasty to conclude that the recent dramatic changes in financing behavior by firms are debilitating to the corporate sector and the macroeconomy. The falling trend in the use of retained earnings could mean that some firms are unable to generate sufficient internally generated funds to undertake profitable investment projects. It could also mean that the market is disciplining inefficient management. The rising trend in the use of debt might not be of concern since firms do take bankruptcy costs into account when they make the capital structure decision. However, there is sufficient evidence to suggest that Internal Revenue Service subsidizes some substantial portion of this rising trend. (Abstract shortened by UMI.)...