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

  • Vlieghe, Gertjan

    (Bank of England)

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

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
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Handle: RePEc:ecj:ac2003:212
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  22. Arellano, Manuel & Bond, Stephen, 1991. "Some Tests of Specification for Panel Data: Monte Carlo Evidence and an Application to Employment Equations," Review of Economic Studies, Wiley Blackwell, vol. 58(2), pages 277-97, April.
  23. Russell Cooper & Joao Ejarque, 2001. "Exhuming Q: market power capital market imperfections," Working Papers 611, Federal Reserve Bank of Minneapolis.
  24. 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.
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