Sources of the Financing Hierarchy for Business Investment

Abstract

What accounts for the apparent preference of firms to finance investment with internal funds? Recent theories stress information problems in capital markets, while older theories emphas ize the transactions costs of external finance. To test these competing hypotheses, the authors estimate the sensitivity of investment spend ing to internal funds across firms likely to face varying degrees of information problems and transactions costs. Several attributes are used to differentiate these firms. The results provide some support for information asymmetries as well as a source of the financing hierarc hy but indicate no significant role for transactions costs. Copyright 1992 by MIT Press.