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.
and underinvests ([I.sup.*] < [I.sup.f]) if the reverse is true.
and underinvests ([I.sup.*](t) < [I.sup.f](t)) if the reverse is true.
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.sup.*] < [I.sup.f] (from now on, the notation will suppress the dependence of [I.sup.*], [e.sup.*], and [r.sup.*] on w and [theta]).
However, holding the rate of return fixed, if there were two groups of firms in this economy, one with a higher marginal cost of external capital than the other, then the group with the higher cost would invest less ("underinvest") compared to the group with the lower cost.
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.
A firm that has many productive opportunities, but has underinvested, could benefit from both raising equity capital (and thereby reducing leverage) and by reducing its dividend payments, to retain more cash to invest in its productive opportunities.