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Financial Frictions and Investment: Requiem in Q

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  • Russell Cooper

    (University of Texas)

  • Joao Ejarque

    (University of Copenhagen)

Abstract

Understanding the nature of financial frictions faced by firms is relevant for both monetary and fiscal policy experiments. Empirical investment studies commonly find that proxies for firms' internal funds are significant as explanatory variables, particularly in the Q-theory based regression framework. These findings are often interpreted as evidence of financial frictions. This paper investigates that inference by specifying and estimating a class of dynamic optimization models where imperfectly competitive firms face financial constraints. Market power induces the principal link between investment and internal funds. We find no evidence to support the argument that capital market imperfections contribute to the relationship between investment and profitability. (Copyright: Elsevier)

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File URL: http://dx.doi.org/10.1016/j.red.2003.08.001
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Bibliographic Info

Article provided by Elsevier for the Society for Economic Dynamics in its journal Review of Economic Dynamics.

Volume (Year): 6 (2003)
Issue (Month): 4 (October)
Pages: 710-728

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Handle: RePEc:red:issued:v:6:y:2003:i:4:p:710-728

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  1. Jason G. Cummins & Kevin A. Hassett & R. Glenn Hubbard, 1994. "A Reconsideration of Investment Behavior Using Tax Reforms as Natural Experiments," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 25(2), pages 1-74.
  2. Steven M. Fazzari & R. Glenn Hubbard & BRUCE C. PETERSEN, 1988. "Financing Constraints and Corporate Investment," Brookings Papers on Economic Activity, Economic Studies Program, The Brookings Institution, vol. 19(1), pages 141-206.
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  8. Bayraktar, Nihal & Sakellaris, Plutarchos & Vermeulen, Philip, 2005. "Real versus financial frictions to capital investment," Working Paper Series, European Central Bank 0566, European Central Bank.
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  15. Janice C. Eberly & Andrew B. Abel, 2004. "Q Theory Without Adjustment Costs & Cash Flow Effects Without Financing Constraints," 2004 Meeting Papers, Society for Economic Dynamics 205, Society for Economic Dynamics.
  16. Simon Gilchrist & Charles Himmelberg, 1998. "Investment, Fundamentals and Finance," NBER Working Papers 6652, National Bureau of Economic Research, Inc.
  17. Tiroley, Jean, 2000. "Corporate Governance," CEI Working Paper Series, Center for Economic Institutions, Institute of Economic Research, Hitotsubashi University 2000-1, Center for Economic Institutions, Institute of Economic Research, Hitotsubashi University.
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