Real Capital Investment Research Articles

Insurers in a Changing and Competitive Financial Structure

The past two decades have ushered in a revolution in the nature of financial institutions. The traditional distinctions between depository institutions, investment banks, insurers, investment companies, pensions, and mutual funds have blurred and, in some cases, virtually disappeared.(1) The motivating forces behind this change appear to originate from two fundamental factors. First, the product line offered to the industry's natural constituents, firms and households, could not be arbitrarily segmented and allocated to various subsectors as had been attempted by previous legislation and regulatory structures. Attempts by regulators to do so were inherently inefficient and opened the way for economic forces consistent with an expansion in the product lines offered by various financial entities. Second, technology ultimately made such regulations, and even locational restrictions, less meaningful as a constraint on the delivery system of financial services. This inevitably led to an expansion of product markets, the substitution of technology, telecommunications, or mail service for physical location, and the development of nearly identical financial products by competing financial entities. In most cases, this has resulted in increased competition and, at the same time, a reduction in the number of competitors in the industry as a whole.(2) These forces should have been apparent as early as the post-Depression era, when the regulations that shaped the industry were formed.(3) But it took years for regulators, and even some industry participants, to see it. Today, it is readily transparent. It is clear that the arbitrary financial divisions separating household and corporate product sectors were doomed to failure. All parts of the industry sought to expand their product menu to satisfy customer needs. The services included a full array of products to provide scarce financial capital to undertake real investment, provide saver services of various kinds, and the pooling of risks of different types. As insurers know, the latter includes actuarial risks, most notably property-liability and mortality risks. However, it also includes myriad financial risks, from liquidity to market risk. In providing investment capital, insurers were prime candidates to finance real capital investment through equity positions in real estate and more traditional corporate equity capital, as well as both standard and nonstandard debt contracts. However, this full array was often limited by regulation - not always in a reasonable or even prudent manner. Over time, however, techniques and instruments emerged to expand the types of investments in insurer portfolios - sometimes with less than satisfactory results.(4) The insurance industry was not alone in this product expansion. It was joined by an incursion of commercial banks into many investment product areas with longer duration investments, such as commercial mortgages, private placement, and, through subsidiaries, the provision of venture capital funds (see Saunders and Walter, 1996). At the same time, the investment banking community realized that a substantial portion of then corporate finance activity was essentially a direct substitute for the more standardized lending functions performed by banks, even at the short end of the maturity spectrum. With investment management firms and various types of mutual funds as anxious purchasers of such products, even more capital flowed to the ever expanding capital market (see Saunders and Walter, 1996). It should be pointed out that no one part of the industry was the predator in this expanding product-line process. Yet, it could be argued that our investment banking community, subject to less explicit product limiting regulation, was the first to see the opportunity to expand its product franchise into broader investment vehicles. The expansion of markets for both pension and retail mutual funds also gave them an easy place to distribute the newly created assets. …

Tobin's q‐Ratio and Market Reaction to Capital Investment Announcements

AbstractThere is a significant positive relation between Tobin's q‐ratio and the magnitude of stock market reaction to capital investment announcements. The findings have the following implications for capital investment theory: (i) The results provide evidence substantiating the link between the q‐ratio and real investment for industrial firms. For public utilities however, no such link exists, (ii) The study finds that average q and marginal q are correlated but the relation is somewhat more complicated than simple equality as assumed by numerous empirical studies. (iii) The findings suggest that investors can use average Tobin's q‐ratio to identify companies with profitable real capital investment opportunities.

A macroeconometric analysis of the effects of taxation on financing and real investment in equipment in Canada

This paper analyses the impact of taxation on corporate financing and corporate investment in machinery and equipment in Canada. A coherent macroeconometric model of the firm's real and financial decision process is theoretically developed and empirically tested on Canadian data. Estimates of the impact of taxation in general and of the 1987 Canadian government's White Paper in particular, are analysed. The estimates suggest that income taxation has a negative but relatively small impact on equipment investment in Canada, and that models that ignore the link between the real and financial decisions overestimate the impact of taxation on real investment. With respect to tax reform, the White Paper reduces the incentive to save and invest in equity capital, and is expected to decrease real capital investment in the long run.

Real vs. financial investment can Tobin taxes eliminate the irreversibility distortion?

In the recent past several developing countries have failed to achieve significant real capital investment despite episodes of large capital inflows. Although there are real projects with seemingly high returns, investors prefer to wait for the correct time to invest. In this paper we address this issue by considering a two-sector economy where investment in real capital is irreversible and debt-financed. Furthermore, the interest rate, which is determined in the financial sector, is random as a result of volatile expectations. In this economy the expected return on real capital is above the expected interest rate. This is because the option to wait for lower interest rates has a positive value. In the presence of rumors, taxes on international financial transactions (Tobin taxes) reduce the variance of the domestic interest rate, while leaving its mean unchanged. As a result, they induce more investment in irreversible real capital. The model borrows from the irreversible investment literature. A difference with other models is that the source of noise is a mean-reverting process not just a geometric Brownian motion. We solve for the optimal decision rule using the Girsanov theorem. Of the maxims of orthodox finance none, surely, is more anti-social than the fetish of liquidity … It forgets that there is no such thing as liquidity of investment for the society as a whole. The introduction of a substantial government transfer tax on all transactions might prove the most serviceable reform available, with a view to mitigating the predominance of speculation over enterprise … Keynes, The General Theory.

Growth Management Good for the Town, Bad for the Nation?

Abstract In his classic economics text the Nobel laureate Paul Samuelson defined what he calls the “fallacy of com-position”: the idea that what is good for one may not necessarily be good for all. His example is personal saving. Although great for the individual, high rates of savings are bad for society because, unless they take the form of real capital investment, they can lead to a recession.