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Financial Frictions, Investment and Tobin’s q

Listed author(s):
  • Lorenzoni, Guido

    ()

    (Department of Economics, MIT)

  • Walentin, Karl

    ()

    (Research Department, Central Bank of Sweden)

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.

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Paper provided by Sveriges Riksbank (Central Bank of Sweden) in its series Working Paper Series with number 208.

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Length: 37 pages
Date of creation: 01 Jun 2007
Handle: RePEc:hhs:rbnkwp:0208
Contact details of provider: Postal:
Sveriges Riksbank, SE-103 37 Stockholm, Sweden

Phone: 08 - 787 00 00
Fax: 08-21 05 31
Web page: http://www.riksbank.com/
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