A 4 percent budget cut may not seem like much to the casual observer, but for a state that already underinvests
in education and health care, it represents potentially significant cuts to services that help Texans compete and succeed, writes Eva DeLuna Castro of the Center for Public Policy Priorities.
Financial theories suggest that the strength of these predictive relations should depend on firm characteristics such as size, risk, the amount of tangible assets compared to intangible assets, and whether the firm over- or underinvests available resources.
This result means that a change in dividends and capital structure provides more information for a firm that over- or underinvests than for a value-maximizing firm that is investing near its optimal level.
The possibility of a systematic association between the signs of the predictive relations (between dividend or capital structure policies and future cash flow) and the firm's tendency to over- or underinvest (Tobin's q) is not amenable to empirical testing.
By the same token, more productive firms are more likely to underinvest.
Cash-rich firms and firms with relatively cheap external capital have a greater tendency to overinvest, while cash-poor firms and firms with relatively costly external capital have a greater tendency to underinvest.
Focusing on an individual firm in isolation, the previous work has established that if the firm's external capital is costly, the firm will underinvest, that is, [I.
The importance of Proposition 2 is in demonstrating that this partial equilibrium observation cannot be invoked to conclude that when capital markets are imperfect, individual firms underinvest relative to the frictionless level.
such that all of the less productive firms overinvest and all of the more productive firms underinvest.
a) either all firms overinvest, all firms underinvest, or there is a cost of external finance c([[theta].
Cash-poor firms are therefore more likely to underinvest, while cash-rich firms are more likely to overinvest.