Journal Article Functional Separability and Partial Elasticities of Substitution Get access R. Robert Russell R. Robert Russell University of California, San Diego Search for other works by this author on: Oxford Academic Google Scholar The Review of Economic Studies, Volume 42, Issue 1, January 1975, Pages 79–85, https://doi.org/10.2307/2296821 Published: 01 January 1975

This article presents an extension of a research project being conducted by the author to study the impact of general price level restatements on published financial information. The parameters selected for analysis were: return on owner's equity, net income, and standard deviation of net income. The paper reported the impact on sequential ordering of the companies under examination as a result of general price level restatement of the underlying data. In the concluding comments of the paper it was stated that: "The financial parameters selected for analysis have not been proved relevant to decision models. The impact of changes in a measurement rule on financial data has been the basis of this analysis. It has been assumed that small relative changes could have relatively small effect on decisions in the absence of specification of an appropriate decision model." The article provides an analysis of the data using portfolio techniques and certain other theories drawn from the field of finance.

Reviews the book "Accounting Theory Illustrated," by David Norr.

T HE standard neoclassical investment analysis postulates a fixed timing relationship between changes in the determinants of the desired stock of capacity and actual investment responses these changes elicit.' There are, however, good reasons to suppose that no such fixed timing relationship exists. This paper seeks to explore one class of variables which could influence firms' decisions concerning the time shape of the investment response to a given change in the desired stock of capacity. The influence of financial conditions on firms' investment decisions has long been recognized.2 What we hope to show is that firms will react differently to a given change in the desired stock of capacity if they are faced with differing financial constraints. Financial variables will play a dual role in the analysis. First, as will be evident below, standard neoclassical investment analysis requires a discount rate to determine the optimal equipment-output ratio. We believe that this discount rate is only mildly responsive to changes in financial market conditions. The relevant discount rate, which includes a substantial risk premium, should exhibit less variance over time than the short term cost of funds.3 Reasons for this lie in the ex post fixity of factor proportions and long term nature of investment in equipment. Financial variables should, however, exert an important impact on the time path chosen for the investment response to a given change in desired capacity. We assume that the cost of funds to the firm depends on the firm's ability to utilize retained earnings (cash flow) as well as the coniditions prevailing in the bond and equity markets. Cost is interpreted in a broad sense and definitely includes the risks which management may believe non-internal financing entails.4 Given this view of firm behavior, we expect that the firm will invest more slowly or postpone investment if it expects that either (a) the costs of not having needed capacity in place are outweighed by the gains to be had from making more extensive use of internal sources of finance during a slow expansion, or (b) the costs of outside sources of finance (or the opportunity cost connected with the investment use of retained earnings) will be lower during subsequent periods to such an extent that it is worth the delay. Firms may hasten their investment response even if this involves additional costs in terms of internal disruption, etc., if these costs are overcome by the present abundance of internal funds or low current finance costs. Section I integrates the effect of financial conditions into the standard analysis to produce an estimable investment relationship. Section II describes the method of estimation. Section III presents results and conclusions.

The article comments on the paper "Segmental Financial Disclosure by Diversified Firms and Security Prices," by R.F. Kochanek, published in the April 1974 issue of the journal "The Accounting Review." Kochanek studied the relationship between segmental disclosure by diversified companies and the forecastability of their earnings. Kochanek's test of the impact of segmental disclosure on earning forecasts employs an indirect measure of the forecastability of earnings. While Kochanek's sample companies are diversified, some would appear to fall primarily into industry groups which vary in earnings volatility. The possible impact of number of segments or industry factors on earnings forecastability bears on Kochanek's results only if quality of reporting varies systematically with number of segments or industry affiliation. To test for this, the authors computed the correlation between number of product lines and Kochanek's disclosure scores. Kochanek executed a creative but inadequately controlled piece of research in attempting to study this relationship.