Econometrica: May 1983, Volume 51, Issue 3

A Financial Theory of Investment Behavior<637:AFTOIB>2.0.CO;2-P
p. 637-646

Erling Steigum, Jr.

This paper analyzes the optimal capital policy of an entrepreneurial firm whose cost of borrowing depends on its debt-equity ratio. The firm chooses the investment plan that maximizes the entrepreneur's intertemporal utility, given static expectations. It is shown that the rate of investment is closely related to the rate of profit retention. It is also demonstrated that the optimal plan can be approximated by a flexible accelerator model of investment. If expectations prove wrong, the investment behavior of the firm could involve instantaneous debt and capital stock adjustment prior to the operation of the flexible accelerator.

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