Are Physical Capacity Constraints Relevant?: Applying Financeâ€Economics Theory to a Management Accounting Misconception

The management accounting literature presents a view that firms normally operate at full physical capacity and consequently often cannot meet customer demand which results in the frequent rejection of profitable business. The financeâ€economics literature presents a contrary view that firms, seeking to maximise their value, will plan for sufficient physical capacity to meet all profitable business. Financeâ€economics theory predicts that firms will have spare capacity since economic constraints apply before physical constraints become relevant. This paper presents the results of an empirical study of Australian manufacturing firms which supports the financeâ€economics view.