Q Theory Without Adjustment Costs & Cash Flow Effects Without Financing Constraints
AbstractTobin's Q exceeds one, even without any adjustment costs, for a firm that earns rents as a result of monopoly power or of decreasing returns to scale in production. Even when there are no adjustment costs and marginal Q is always equal to one, Tobin's Q is informative about the firm's growth prospects. We show that investment is positively related to Tobin's Q (which is observable average Q). This effect can be quantitatively small, which has been taken as evidence of very high adjustment costs in the empirical literature, but here is consistent with no adjustment costs at all. In addition, cash flow has a positive effect on investment, and this effect is larger for smaller, faster growing and more volatile firms, even though capital markets are perfect. These results provide a new theoretical foundation for Q theory and also cast doubt on evidence of financing constraints based on cash flow effects on investment
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Bibliographic InfoPaper provided by Society for Economic Dynamics in its series 2004 Meeting Papers with number 205.
Date of creation: 2004
Date of revision:
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Postal: Society for Economic Dynamics Christian Zimmermann Economic Research Federal Reserve Bank of St. Louis PO Box 442 St. Louis MO 63166-0442 USA
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Q Theory; Cash Flow; Investment;
Find related papers by JEL classification:
- E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Capital; Investment; Capacity
This paper has been announced in the following NEP Reports:
- NEP-ACC-2004-08-02 (Accounting & Auditing)
- NEP-ALL-2004-08-02 (All new papers)
- NEP-ENT-2004-08-02 (Entrepreneurship)
- NEP-MAC-2004-08-02 (Macroeconomics)
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- William C. Brainard & James Tobin, 1968. "Pitfalls in Financial Model-Building," Cowles Foundation Discussion Papers 244, Cowles Foundation for Research in Economics, Yale University.
- Russell Cooper & Joao Ejarque, 2000.
"Exhuming Q: Market Power vs. Capital Market Imperfections,"
Econometric Society World Congress 2000 Contributed Papers
0528, Econometric Society.
- Russell Cooper & Joao Ejarque, 2001. "Exhuming Q: Market Power vs. Capital Market Imperfections," NBER Working Papers 8182, National Bureau of Economic Research, Inc.
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