Milne, Alistair Keith Lovell
(1991)
Inventory investment in the UK: Excess volatility, financial effects and the cost of capital.
PhD thesis, London School of Economics and Political Science.
Abstract
This thesis consists of four self-standing papers (chapter 2 through chapter 5) together with an introduction (chapter 1) and a conclusion (chapter 6). Chapter 2 examines the data on UK inventory investment. Excess volatility is a minor feature. The cyclical movements of inventory investment - examined using tabulations and graphical techniques - are much more prominent, apply to all categories of inventories, and data encompass the observed excess volatility. A frequency domain analysis (using a simple but novel technique) confirms this finding. The cyclical movements in the frequency domain correspond to slow speed of adjustment in the time domain. These results suggest that the explanation of excess volatility is a degenerate research programme and should be abandoned in favour of a return to explaining the cyclical movements of inventory investment Chapter 3 considers the mis-specification testing of the linear quadratic production smoothing model of inventories previously estimated by Blanchard (1983). Estimation results, under instrumental variable estimation, depend on the normalisation of the estimated first order condition. The model is encompassed by, but does not encompass, the alternative stock-adjustment model of Lovell (1961). The West (1986) variance inequality is shown to be equivalent to the setting of some lower bound on residual variance. Chapter 4 analyses a dynamic model with bankruptcy, under simplifying exogeneity assumptions about financial contracts. When there are constraints on the availability of both debt and equity, then inventory holdings depend on net assets during periods of financial pressure. This implies a link between inventory investment and profitability for firms under financial pressure. Estimation using a panel of UK company accounts provides striking confirmation of this relationship. Aggregation over the panel indicates that the effects of profits explains a large part of the movements in aggregate UK inventory investment. Chapter 5 provides a detailed analysis of the determinants of the cost of capital for inventory investment paying particular attention to the effects of UK stock relief legislation. The IFS tax model is used to calculate aggregate and sectoral measures of the cost of capital. The tax position of individual companies does not greatly affect the aggregate cost of capital. Stock relief legislation lowers the aggregate cost of capital, by more in the 4th and 1st quarters than in the 2nd and 3rd quarters of each year.
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