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Published online by Cambridge University Press: 11 May 2010
Discussion of the role of internally generated funds as a dynamic and influential determinant of investment decisions has been renewed lately in the macroeconomic investment literature. While there is a current revival, the hypothesis is not a new one. In the classic study of the financial history of eight leading American automobile manufacturers over the period 1910 to 1926, Lawrence H. Seltzer concludes that “the greatest part of the growth in their capital resources was derived from reinvested profits; and that this source accounts for much the greater part of their present invested capital.” He estimates that for the period through 1926 net aggregate reinvested profits were equal, on average, to almost 80 percent of the value of tangible invested capital.3 Seltzer suggests that this remarkably high percentage was the result of the unique situation of the automobile industry, although carefully pointing out that the general importance of internal funds may be greater than commonly realized.
1 The early theoretical development was made by Duesenberry, James S., Business Cycles and Economic Growth (New York: McGraw-Hill, 1958).Google Scholar Some of those who tested the hypothesis for postwar data have been: Anderson, W. H. Locke, Corporate Finance and Fixed Investment: An Economic Study (Boston: Harvard University Press, 1964)Google Scholar; Meyer, John R. and Glauber, R. R., Investment Decisions, Economic Forecasting and Public Policy (Cambridge, Massachusetts: Harvard University Press, 1964)Google Scholar; Evans, Michael K., “A Study of Industry Investment Decisions,” The Review of Economics and Statistics, LIX (May 1967)Google Scholar; Coen, Robert M., “Effects of Tax Policy on Investment in Manufacturing,” American Economic Review, LXIII (May 1968)Google Scholar; and Resek, R. W., “Investment by Manufacturing Firms,” The Review of Economics and Statistics, XLVIII (Aug. 1966).Google Scholar The disaggregated studies of Anderson, Evans, and Resek generally find that the coefficient on internal funds (variously measured) is not significant or of the wrong sign in regressions for the post World War II automobile industry investment decision. See Evans, “A Study of Industry Investment Decisions,” p. 158 for comments on this finding.
2 Seltzer, Lawrence H., A Financial History of the American Automobile Industry (New York: Houghton Mifflin Company, 1928), p. 265.Google Scholar
3 Ibid, p. 266.
4 Ibid, p. 274.
5 Okun, Arthur M., The Political Economy of Prosperity (Washington, D.C.: Brookings Institution, 1970), p. 19.Google Scholar
6 Eisner, Robert, “A Permanent Income Theory for Investment: Some Empirical Explorations,” The American Economic Review, LVII (June 1967), p. 386.Google Scholar
7 Coen, “Effects of Tax Policy on Investment in Manufacturing,” pp. 207–8. This involves substituting 
for K and subtracting (1 — δ) GIt-1 from both sides of the equations. After simplification, the independent variables take on the form ΔX = Xt − (1−δ) Xt−1, where X is any independent variable. This derivation and model is also found in L. J. Mercer and W. D. Morgan, “The American Automobile Industry: Investment Demand, Capacity and Capacity Utilization, 1921–1940,” Journal of Political Economy (Nov./Dec. 1972).
8 The data sources and description are found in the Statistical Appendix.
9 To obtain (3) it is necessary to know the value of investment requirements which means the values.of K and K* are needed. The value of capital is taken from L. J. Mercer and W. D. Morgan, “The American Automobile Industry: Investment Demand.…” The value of K* is found by solving equation (2) for K* using the coefficients for γ1 and γ2 from equation (1.1) in Table 1 and the values of II, K and ĜI. This solution is:
where ĜI is estimated gross investment from (1.1).
10 To further evaluate the particular structural form used in the regressions, equation (1.2) was estimated substituting cash flow for output. The results were singularly poor. The R2 was .68 and standard error was 22.7 with a t-statistic on weighted cash flow of only 1.7. These results support the structural form used here to evaluate the role of cash flow.
11 Total real sales is calculated from data in Shaw, William H., Commodity Output Since 1869 (New York: National Bureau of Economic Research, 1947), pp. 68–69 and 292–95.Google Scholar
