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The roles of expected profitability, Tobin's Q and cash flow in econometric models of company investment

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Listed author(s):
  • Vlieghe, Gertjan

    (Bank of England)

  • Stephen Bond
  • Alexander Klemm
  • Rain Newton-Smith
  • Murtaza Syed

Abstract

Evidence that cash flow has a significant effect on investment after controlling for Tobin's average Q has been interpreted as suggesting the importance of financing constraints. Recent work shows that the Q model may not be identified if there are `bubbles' in stock market valuations that are persistent and correlated with fundamental values. Cash flow may then provide additional information about expected profitability that is not captured by average Q. Using data on UK companies, we find severe measurement error in average Q. We find that cash flow becomes insignificant after controlling for expected profitability using analysts' earnings forecasts (I/B/E/S).

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Paper provided by Royal Economic Society in its series Royal Economic Society Annual Conference 2003 with number 212.

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Date of creation: 04 Jun 2003
Handle: RePEc:ecj:ac2003:212
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Keywords: panel data; investment; financing constraints; Q Model; share prices;

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Find related papers by JEL classification:
  • C23 - Mathematical and Quantitative Methods - - Single Equation Models; Single Variables - - - Models with Panel Data; Spatio-temporal Models
  • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
  • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
  • G3 - Financial Economics - - Corporate Finance and Governance

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  1. Gilchrist, Simon & Himmelberg, Charles P., 1995. "Evidence on the role of cash flow for investment," Journal of Monetary Economics, Elsevier, vol. 36(3), pages 541-572, December.
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  26. Blundell, Richard & Bond, Stephen & Devereux, Michael & Schiantarelli, Fabio, 1992. "Investment and Tobin's Q: Evidence from company panel data," Journal of Econometrics, Elsevier, vol. 51(1-2), pages 233-257.
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