Dynamic Investment Models and the Firm's Financial Policy

The aim of this paper is to characterize the empirical implications for dynamic investment models of the hierarchy of finance model of corporate finance and to test these implications using firm level data. The model we estimate is based on the Euler equation for optimal capital accumulation in the presence of convex adjustment costs. The theoretical model explicitly allows for debt finance and considers the implications of allowing firms to accumulate financial assets. The empirical investigation uses UK company panel data to estimate dynamic investment models by GMM and to test the derived implications.