DYNAMIC INVESTMENT MODELS AND THE FIRM FINANCIAL POLICY

In this paper we investigate the sensitivity of investment to the avai lability of internal funds using the hierarchy of finance approach to corporate finance. We characterize the empirical implications of this approach for dynamic investment models and test these implications usi ng firm-level data. The model we estimate is based on the Euler equati on for optimal capital accumulation in the presence of convex adjustme nt costs. The theoretical model explicitly allows for debt finance and financial assets. The empirical investigation uses U.K. company panel data to estimate dynamic investment models using GMM and tests the de rived implications.