Capital Investment and Earnings: International Evidence

In this paper, we examine dynamic relations between earnings and capital investment in an international context. Using firm level data from 40 different countries, we examine the causality relationships and cumulative impact of lagged earnings (capital investment) on capital investment (earnings) both for individual countries, and for country groups categorized as G7 vs. non-G7, civil law vs. common law, and financially developed vs. undeveloped. Overall, we find that earnings Granger-cause investment, and there is weaker evidence on the causation in the reverse direction. There are differences between G7 vs. non-G7, financially developed vs. undeveloped, and civil law vs. common law groups. Our results suggest that internal financing is a significant constraint for investment for most countries, and that legal environment (e.g., corporate governance) and financial development are important in the profitability of capital investment. The results are robust to including year dummies, using cash flows in place of earnings, and using changes in the variables in lieu of levels