Growth and Finance of the Firm. Models of Firm Behavior Tested on Data from Swedish Industrial Firms

Financial conditions, investment behavior and growth of the firm have been a central area of inquiry at the Industrial Institute for Economic and Social Research (IUI) for a long time. This publication "Growth and Finance of the Firm" contains a systematic theoretical inquiry into this topic. The analysis starts from that branch of recent literature in which the mutual dependence of financial and investment decisions are emphasized. A capital value maximizing firm with well specified conditions of production and financing constitutes the core of the theoretical part of the book. The main purpose is to demonstrate the optimization process behind production, investment and financing decisions at the firm level and to show how these three decisions are interrelated. An attempt is also made to determine the optimal values of the firm's decision variables with goal functions including the rate of return, the rate of growth and the capital value and also to study how these solutions are influenced by changes in exogenous factors such as input prices, the corporate income tax rate, financial parameters, etc. In another section of the book assumptions made and theoretical results arrived at are tested empirically at the firm level. The data used are the survey statistics of the Swedish Engineering Employers' Association and annual reports of manufacturing companies quoted on the Stockholm Stock Exchange. One empirical conclusion is that the rate of return is negatively influenced by the rate of growth. This result suggests the existence of costs associated with raising the rate of growth. These empirical tests also support the well-known hypothesis that the interest rate and stockholders' required rate of return rise with the leverage ratio and decrease with the pay-out ratio. The book is written by Dr Göran Eriksson. A Swedish language version of it was submitted as his doctoral thesis at the University of Stockholm. We wish to thank Professor Hans Brems at the University of Illinois for several valuable suggestions that have improved the English version of the book in many important respects. Earlier versions of the manuscript have been discussed in seminars at the IUI and at the Stockholm University. Professor Lars Werin's interest and knowledge have contributed greatly to this book Thanks also go to Professor Börje Kragh, Dr Claes-Henric Siven and Dr Alex Markowski for valuable comments. Mr William Melton has translated the book into English and the translation has partly been financed by "Statens Råd för Samhällsforskning". Stockholm in November 1977 Gunnar Eliasson The Industrial Institute for Economic and Social Research, Stockholm