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Financial Frictions, Investment and Tobin’s q

Author

Listed:
  • Lorenzoni, Guido

    () (Department of Economics, MIT)

  • Walentin, Karl

    () (Research Department, Central Bank of Sweden)

Abstract

We develop a model of investment with financial constraints and use it to investigate the relation between investment and Tobin’s q. Afirm is financed partly by insiders, who control its assets, and partly by outside investors. When their wealth is scarce, insiders earn a rate of return higher than the market rate of return, i.e., they receive a quasi rent on invested capital. This rent is priced into the value of the firm, so Tobin’s q is driven by two forces: changes in the value of invested capital, and changes in the valu of the insiders’ future rents per unit of capital. This weakens the correlation between q and investment, relative to the frictionless benchmark. We present a calibrated version of the model, which, due to this effect, generates realistic correlations between investment, q, and cash flow.

Suggested Citation

  • Lorenzoni, Guido & Walentin, Karl, 2007. "Financial Frictions, Investment and Tobin’s q," Working Paper Series 208, Sveriges Riksbank (Central Bank of Sweden).
  • Handle: RePEc:hhs:rbnkwp:0208
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    References listed on IDEAS

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    Cited by:

    1. Rampini, Adriano A. & Viswanathan, S., 2013. "Collateral and capital structure," Journal of Financial Economics, Elsevier, vol. 109(2), pages 466-492.
    2. Zheng Liu & Pengfei Wang & Tao Zha, 2009. "Do credit constraints amplify macroeconomic fluctuations?," Working Paper Series 2009-28, Federal Reserve Bank of San Francisco.
    3. François Gourio & Leena Rudanko, 2014. "Customer Capital," Review of Economic Studies, Oxford University Press, vol. 81(3), pages 1102-1136.
    4. Michael R. Roberts, 2014. "The Role of Dynamic Renegotiation and Asymmetric Information in Financial Contracting," NBER Working Papers 20484, National Bureau of Economic Research, Inc.
    5. Peter N. Gal & Gabor Pinter, 2017. "Capital over the Business Cycle: Renting versus Ownership," Journal of Money, Credit and Banking, Blackwell Publishing, vol. 49(6), pages 1299-1338, September.
    6. Walentin, Karl, 2014. "Expectation driven business cycles with limited enforcement," Economics Letters, Elsevier, vol. 124(2), pages 300-303.
    7. Claessens, Stijn & Ueda, Kenichi & Yafeh, Yishay, 2014. "Institutions and financial frictions: Estimating with structural restrictions on firm value and investment," Journal of Development Economics, Elsevier, vol. 110(C), pages 107-122.
    8. repec:eee:reveco:v:53:y:2018:i:c:p:109-117 is not listed on IDEAS
    9. Sandro Brusco & Eva Ropero, 2007. "Financing Constraints and Firm Dynamics with Durable Capital," Department of Economics Working Papers 07-08, Stony Brook University, Department of Economics.
    10. Patrick Bolton & Neng Wang & Jinqiang Yang, 2015. "Liquidity and Risk Management: Coordinating Investment and Compensation Policies," NBER Working Papers 20979, National Bureau of Economic Research, Inc.
    11. Roberts, Michael R., 2015. "The role of dynamic renegotiation and asymmetric information in financial contracting," Journal of Financial Economics, Elsevier, vol. 116(1), pages 61-81.
    12. Patrick Bolton & Neng Wang & Jinqiang Yang, 2016. "Liquidity and Risk Management: Coordinating Investment and Compensation Policies," 2016 Meeting Papers 1703, Society for Economic Dynamics.
    13. Dan Vu Cao, 2010. "Collateral Shortages, Asset Price And Investment Volatility With Heterogeneous Beliefs," 2010 Meeting Papers 1233, Society for Economic Dynamics.
    14. Wang, Chong & Wang, Neng & Yang, Jinqiang, 2012. "A unified model of entrepreneurship dynamics," Journal of Financial Economics, Elsevier, vol. 106(1), pages 1-23.
    15. Claessens, Stijn & Ueda, Kenichi & Yafeh, Yishay, 2010. "Financial Frictions, Investment, and Institutions," CEPR Discussion Papers 8170, C.E.P.R. Discussion Papers.
    16. Pedro Elosegui & Paula Español & Demian Panigo & Juan Sotes Paladino, 2006. "Methodological Alternatives for the Analysis of Financial Constraints in Argentina," BCRA Working Paper Series 200602, Central Bank of Argentina, Economic Research Department.
    17. Ai, Hengjie & Li, Rui, 2015. "Investment and CEO compensation under limited commitment," Journal of Financial Economics, Elsevier, vol. 116(3), pages 452-472.

    More about this item

    Keywords

    Financial constraints; investment; Tobin’s q; limited enforcement.;

    JEL classification:

    • E22 - Macroeconomics and Monetary Economics - - Consumption, Saving, Production, Employment, and Investment - - - Investment; Capital; Intangible Capital; Capacity
    • E30 - Macroeconomics and Monetary Economics - - Prices, Business Fluctuations, and Cycles - - - General (includes Measurement and Data)
    • E44 - Macroeconomics and Monetary Economics - - Money and Interest Rates - - - Financial Markets and the Macroeconomy
    • G30 - Financial Economics - - Corporate Finance and Governance - - - General

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