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Financial Frictions, Investment and Tobin’s q

  • Karl Walentin

    (Sveriges Riksbank (Bank of Sweden))

  • Guido Lorenzoni

    (Northwestern University)

  • Dan Cao

    (Georgetown University)

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 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 value 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 Society for Economic Dynamics in its series 2013 Meeting Papers with number 634.

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Date of creation: 2013
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Handle: RePEc:red:sed013:634
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