Value maximization and the information content of corporate investment with respect to earnings

In this paper we study the dynamic nature of the relationship between earnings and investment. If managers act as wealth maximizers, we would expect that new investments should lead to increased earnings. However, past research has found that investment is not causally prior to earnings. Using recent developments in time-series econometrics, we show that the dynamic nature of the relationship between earnings and investment exhibits bi-directional causality, Our results are consistent with managers investing in positive NPV projects, but managers appear to face financing constraints because investment decisions are driven by the availability of internally generated earnings.