The article presents a study using the Euler equation for capital accumulation by individual business firms. First, authors' use an estimation strategy based on the Euler equation representation of firms' investment decisions. This strategy reflects reservations with standard investment models based on the q theory with adjustment costs. In particular, there are well-known problems in measuring marginal q, as well as concerns that observed stock market valuations may not accord with the predictions of the efficient markets hypothesis. Second, it explores the reasons why the standard Euler equation for fixed investment may not fit well for all firms. Authors' starting point is a comparison of the investment of one set of firms for which the neoclassical model is assumed to hold to the investment of another set for which "financing constraints" are assumed to be important. The orthogonality conditions implied by the standard model are decisively rejected for firms with low presample payout ratios.
Hubbard, R. Glenn, Anil Kashyap, and Toni Whited. "Internal Finance and Firm-Level Investment." Journal of Money, Credit, and Banking 27, no. 3 (August 1995): 683-701.
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