Investment and Finance Under Fundamental Uncertainty

This dissertation reports an application of Critical Realist methodology to the problem of identifying the causal relationships between corporate finance and industrial investment. The study employs both econometric analysis of aggregate time-series data for the UK and US for the period 1952-2001 and other quantitative methods, including an analysis of individual cashflow statements, as well as qualitative studies of the annual reports and financial statements of individual firms. The econometric analysis consists mainly of the estimation and testing of single equation and vector error correction models based on a co-integrating relationship. The aggregate data reveal the anomaly that large industrial firms invariably use equity markets to finance business acquisitions but not capital formation. This can be explained by a differential new equity issue discount based on a fresh interpretation of Keynes’s analysis of liquidity preference under fundamental uncertainty. This account makes an important link between the theories of Keynes and Kalecki. The resulting hypothesis is tested and confirmed by an individual study of all 217 new issues over £1m made by continuing UK listed industrial companies in 1999. The thesis concludes that public policy and future research on aggregate investment will be more fruitful if based upon the Post Keynesian understanding of uncertainty, although this requires a major reconsideration of current standard theoretical and empirical methodologies. A distinctive conclusion is that econometric analysis can reveal the detailed nature of regular patterns grounded in conventional behaviour and institutions, but must not be used uncritically in the framing and testing of economic hypotheses