What Moves Investment Growth?

Abstract

We study the determinants of corporate investment growth in the U.S. We use accounting identities to develop a system in which unexpected changes in investment growth are decomposed into surprises to current earnings growth, surprises to current stock returns, revisions of expectations about future cash flow growth, and revisions of expectations about future discount rates. Using a vector autoregressive model we find that the lion's share of variation in investment growth is strongly related to surprises to current earnings growth instead of news about the future, which suggests that the bulk of investment is myopic instead of forward-looking. This happens because neither cash holdings nor net payout (including external financing) vary enough to break the link between earnings shocks and investment. In a simple q-model we are able to replicate the large comovement of investment growth and surprises to current earnings growth, but at the cost of producing a counterfactually high comovement of investment growth and return surprises.

Keywords: aggregate investment, variance decomposition, q-theory, earnings shocks, cash flow news, discount rate news

JEL Classification: E22, G12