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Financial Frictions and Investment: Requiem in Q

  • Russell Cooper

    (University of Texas)

  • Joao Ejarque

    (University of Copenhagen)

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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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. Tirole, Jean, 1999. "Corporate Governance," CEPR Discussion Papers 2086, C.E.P.R. Discussion Papers.
  2. Russell Cooper & Joao Ejarque, 2000. "Exhuming Q: Market Power vs. Capital Market Imperfections," Econometric Society World Congress 2000 Contributed Papers 0528, Econometric Society.
  3. Simon Gilchrist & Charles P. Himmelberg, 1995. "Evidence on the Role of Cash Flow for Investment," Working Papers 95-01, New York University, Leonard N. Stern School of Business, Department of Economics.
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  11. 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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  14. Tauchen, George, 1986. "Finite state markov-chain approximations to univariate and vector autoregressions," Economics Letters, Elsevier, vol. 20(2), pages 177-181.
  15. Timothy Erickson & Toni M. Whited, 2000. "Measurement Error and the Relationship between Investment and q," Journal of Political Economy, University of Chicago Press, vol. 108(5), pages 1027-1057, October.
  16. Bayraktar, Nihal & Sakellaris, Plutarchos & Vermeulen, Philip, 2005. "Real versus financial frictions to capital investment," Working Paper Series 0566, European Central Bank.
  17. Whited, Toni M., 2006. "External finance constraints and the intertemporal pattern of intermittent investment," Journal of Financial Economics, Elsevier, vol. 81(3), pages 467-502, September.
  18. Janice C. Eberly & Andrew B. Abel, 2004. "Q Theory Without Adjustment Costs & Cash Flow Effects Without Financing Constraints," 2004 Meeting Papers 205, Society for Economic Dynamics.
  19. 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.
  20. Russell W. Cooper & John C. Haltiwanger, 2000. "On the Nature of Capital Adjustment Costs," NBER Working Papers 7925, National Bureau of Economic Research, Inc.
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