THE NEOCLASSICAL MODEL, CORPORATE RETAINED EARNINGS, AND THE REGIONAL FLOWS OF FINANCIAL CAPITAL

Abstract

Regional capital expenditures, which reflect regional flows of financial capital, are a function of the aggregate of individual firms' behavior. Hence, the allocational efficiency of the regional flows of financial capital may be affected by the manner--internal versus external--in which financial capital becomes available to manufacturing firms. Allocational inefficiency (sub-optimal allocation of financial capital) could obtain since corporate retained earnings - the amount of funds that are internally available to large firms - are only minimally subject to the market rationing process. Even though the capital market is cleared, it may do so without providing for the efficient allocation of financial capital. The existence of differential rates in regional financial markets may reflect the costs associated with the use of funds in a truncated or discontinuous national capital market. Accordingly, equilibrium experienced in the capital market may exist under non- Paretian conditions. This paper attempts to determine whether the allocation of regional financial capital flows is efficient as suggested by the neoclassical model (NCM). Specifically, the study attempts to ascertain whether corporate retained earnings model (CREM) is a better predictor of the regional flow of financial capital than the NCM. In accordance with the NCM, for the period under study, it is hypothesized that: regions with high rates of return are regions with high growth rates of corporate income that experience lower variability of annual capital investments than regions with low rates of return. In accordance with the CREM, it is postulated that regions with high average annual capital investment-output ratios are regions with high corporate income and low average rates of return on corporate assets. Surrogate measures of financial capital flows and the volatility of such flows were used. The test results, which may not be generalizable beyond the study period, suggest that the CREM may be a better predictor of the regional flow of financial capital than the NCM and that the financial capital rationing process for regional manufacturing investments may be inefficient. The finding, that the corporate earnings retention influences the flow of financial capital, does suggest that the NCM does not always hold. This study should enhance the understanding of regional flows of financial capital and the models (revolving around the state- region and industry region) used in the study refine and extend the scope of regional economic analysis.internal and external financing; allocational efficiency, industry regions, dominant industry; universal investment opportunity set (UIOS); firm’s investment opportunity set (FIOS).