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Financial Frictions, Investment and Tobin's q

  • Guido Lorenzoni
  • Karl Walentin

    ()

    (Research Division Sveriges Riksbank (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. A firm is financed partly by insiders, who control its assets, and partly by outside investors. When insiders’ wealth is scarce, they earn a rate of return higher than the market rate of return, i.e. insiders earn 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 value of the insiders’ future rents. The second effect weakens the correlation between q and investment. We calibrate the model and show that, thanks to this effect, the model can generate realistic correlations between investment, q and cash flow

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Paper provided by Society for Economic Dynamics in its series 2006 Meeting Papers with number 844.

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Date of creation: 03 Dec 2006
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Handle: RePEc:red:sed006:844
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