Abstract
To some readers it may seem a little suspect that we focus our study on the firm’s formulations of its goal function. It is not uncommonly felt that the professional contribution of the advisory economist should be restricted to investigating the consequences of different acts in a decision situation. Naturally even such limited tasks have to be related to the goals applicable in the relevant situation, but it could be claimed that the decision-maker should be solely responsible for precisely formulating his goals, thus furnishing the starting-point for the economist’s work. Obviously advice will be impossible unless the decision-maker broadly outlines his goal(s) and relevant courses of action. The task of the economist (the advisor) will then be to substitute for such a broad description a formal decision model which the decion-maker can accept. And in accepting the model as a whole, he naturally accepts too the goal function embodied in it. This necessary acceptance does not prevent the economist from playing just as active a role in the detailed formulation of the goals as in the specification of acts and the precise description of the various outcomes. The close relation between these elements in the model provides confirmation of this. The class of decision models that we shall discuss are deterministic (i.e. they contain no stochastic variables) and concern the firm’s choice between different investment and financing alternatives. A considerable amount of literature on this subject already exists and it seems important even at this early stage to point out in a general way how the present work fits into the picture. It may be said that a well established investment theory exists only for the special case of the firm functioning in a perfect capital market. In such a market all the participants agree in a definite conception of the investment opportunities and their consequences. The firm can therefor borrow on the various investments up to the discounted value of the future net receipts. The rate of interest is the same for borrowing and lending for all firms and persons on the market. It is also normally regarded as constant over time. There are no transaction costs. Under these circumstances writers are unanimous in declaring that when an economically rational decision-maker evaluates the investments open to him, he should rank them according to their present value at the market rate of interest. What, then, can be said about firms working in a capital market with credit restrictions, different rates of interest, taxes and other market imperfections? How are they to formulate their goals? It is our view that statements so far to be found in the literature are generally based on the rather loose analogies with the case of the perfect capital market. Our aim here is to develop two reasonable analogies somewhat more fully than has been usual before. Contents . CHAPTER 1 . INTRODUCTION1.1 The Aim and the Frame of Reference of the Study1.2 Goal Formulation and Model-Building in Investment Theory.1.3 Courses of Action and their Outcomes.1.4 Basic Assumptions concerning the Firm's Goal Formulation.1.5 Goal Formulation in this Study and in Welfare Economics. CHAPTER 2 . THE FIRM’S TRANSFORMATION OPPORTUNITIES AS THE BASIS FOR THE APPLICABILITY OF CERTAIN GOAL FUNCTIONS IN THE EVALUATION OF INVESTMENT AND FINANCING ACTIVITIES. 2.1 The Applicability of the Present Value Approach to Investment and Financing Evaluations. 2.2 The Applicabilityof the Internal Rate of Return Approach to Investment and Financing Evaluations. 2.3 The Applicability of the Payoff Approach to the Evaluation of Single Investment Projects. 2.4 Summary. Some Comments on Our Conclusions. 2.5 Our Study in the Light of Some Developments in Investment Theory. CHAPTER 3 . THE STOCK MARKET AS THE BASIS FOR THE APPLICABILITY OF CERTAIN GOAL FUNCTIONS IN THE FIRM’S EVALUATION OF INVESTMENT AND FINANCING ACTIVITIES. 3.1 A Simple Model of the Market Value of Stock. 3.2 The Owners’ Tax Conditions and the Importance of the Stock Market for the Choice of Goal Function in Corporations Listed on the Stock Exchange. 3.3 Some Comments on the Effect of Transaction Costs and Different Interest Rates on the Choice of Goal Function in Corporations Listed on the Stock Exchange. 3.4 Some Comments on the Importance of the Stock Market for the Choice of Goal Function in Firms not Listed on the Stock Exchange. 3.5 Comments on Some Literature Concerning the Stock Market and the Corporation’s Investment and Financing Activities