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- Title
ON THE LINKAGE BETWEEN CORPORATE SAVING AND EARNINGS GROWTH.
- Authors
Buell, Stephen G.; Beidleman, Carl; Moyer, R. Charles
- Abstract
Financial theory asserts that if the proportion of externally financed investment remains constant over time, there is a direct relationship between the fraction that a firm retains from its profits and the rate of earnings growth that it experiences in subsequent periods. If retained profits are invested at a rate in excess of their cost, they should produce higher future earnings and dividends and eventually higher equity prices (i.e., capital gains), and thereby work to the advantage of a common stock investor. This basic conclusion was challenged by I.M.D. Little in 1962 and later by Baumol, Heim, Malkiel, and Quandt (BHMQ) in 1970 and others [1, 2, 3, 4, 5]. Both the Little and the BHMQ studies presented evidence that suggested that the relationship between earnings retention and subsequent growth was very weak or non-existent. A close examination of these studies shows them to suffer from a sufficient number of econometric and specification problems to cast doubt on the validity of their results. For example, Little has failed to consider debt and common stock financing, thereby implicity attributing all changes in earnings to the ploughing back of profits. He also implicitly assumed that the profitability of the stock of exisiting assets remained constant, an untenable assumption in light of the decline in corporate profits that occured during the 1950's, the period surveyed by Little. BHMQ also failed to account for changes in the profitability of existing assets. In addition, they employed a very heterogeneous sample. The purpose of this paper is to evaluate the strength of the ploughback-growth linkage using a model that is free of some of the biases of the earlier studies.
- Publication
Journal of Financial Research, 1981, Vol 4, Issue 2, p121
- ISSN
0270-2592
- Publication type
Academic Journal
- DOI
10.1111/j.1475-6803.1981.tb00614.x