General Theory of the Firm : Business Investment Decision

To overcome the fragmentary nature of the investment theory in the economic literature, this paper is aimed at developing a more holistic analysis framework of business investment decision. It used deductive reasoning based on the premise that investment decision of the company results from a compromise between managers, lenders and shareholders, with profitability and funding constraints. Thus, by gradually lifting the classical assumptions relating to capital markets, several theoretical results have been obtained, of which four can be considered as major. According to the first result, for each of the individual funding sources, the firm’s optimal investment strategy is such as the sum of the marginal capital productivity and the marginal transaction costs of the capital market is equal to the sum of the user cost of capital, the marginal transaction costs of the labor market and the marginal opportunity cost of funding constraints. Considering the equity market and the lending funds market, the second result shows that the optimal investment strategy is such as the total marginal costs of financing minus the total marginal transaction costs on these markets are equal. Thus, the third result reveals that the optimal investment strategy depends on the financing structure if and only if the capital markets are hetero-expensive. According to the fourth result, the optimal funding structure is such as the investor’s marginal preference for equity over lending funds is equal to one plus the ratio between, on the one hand, the total marginal financing costs minus the marginal transaction costs of potential financial guarantees; and on the other hand, the marginal transaction costs of the equity-financed investment. The fifth result shows that the relationship between investment and interest rate is not monotonous: it is positive when funding constraints are high and net capital profitability is high enough, otherwise it is negative.