sions are interdependent, and simultaneous equations must be used to esti-
mate the equations econometrically.
The goal of this study is to test empirically the independence of finan-
cial decisions hypothesis using the Guerard, Bean, and Andrews (1987)
framework of effective debt. Guerard and Stone developed and estimated
their model using a set of simultaneous equations employing the 303-firm
sample during the 1978–1982 period, as described in Guerard and Mc-
Cabe (1992). We update the Guerard, Bean, and Andrews (1987) study
and compare its initial 1987 results with those derived from the U.S. firms
in the WRDS database for the 1952–2002 period. We find stronger evi-
dence of the interdependence of financial decisions using the larger U.S.
firms in the WRDS database than we reported in Guerard, Bean, and An-
drews (1987) using the Guerard and McCabe and Guerard, Bean, and
Stone (1990) 303-firm database for the 1978–1982 period. There is
stronger evidence that U.S. financial decisions are interdependent.
The Model
The model we developed employs investment, dividends, and new capital
financing equations to describe the budget constraint facing the manager of
a manufacturing firm. The manager may use available funds to undertake
capitalized research and development activities (RDS) or new investment
(IS), or to pay dividends (DS) or increase net working capital (CAK). The
sources of funds are represented by net income (PK), depreciation (DEP),
and new debt issues (FS):
RDS + IS + CAK = PK + DEP – DS + FS + NEQ (6.1)where CAK = increase in net current assets
NEQ = net new equity issues
Intercept = regression intercept
DE = debt-to-equity ratio
INTE = average cost of interest expense
DEPK = depreciation/capital stock
RDL = last year’s R&D expenses/sales
Size = 1/total assets
PKL = last year’s profits/capital stock