The roles of expected profitability, Tobin's Q and cash flow in econometric models of company investment
By: by Stephen Bond, Alexander Klemm, Rain Newton-Smith, Murtaza Syed and Gertjan Vlieghe.
Contributors: Bond, Stephen.; Bank of England.
Series: Working paper,; no. 222; Working paper (Bank of England : Online) ;; no.222.
Publisher: Bank of England
Published: 2004
Place of publication: London
Language: eng
Format: Electronic resource
Subjects: Capital investments -- Econometric models.; Cash flow -- Econometric models.
Description: "Evidence that cash flow has a significant effect on company investment spending, after controlling for Tobin's average Q, has often been interpreted as suggesting the importance of financing constraints. Recent work on measurement error in the Q model casts doubt on this interpretation. It is possible that the Q model may not be identified if there are 'bubbles' in stock market valuations that are both persistent over time and that are correlated with fundamental values. Cash flow may then provide additional information about expected profitability that is not captured by a poorly measured Tobin's average Q variable. This hypothesis is explored empirically using UK panel data on companies for which analysts' earnings forecasts are available from the IBES database. The results point to a severe measurement error in average Q. The paper finds that, controlling for expected profitability using analysts' earnings forecasts, cash flow becomes insignificant. Both sales growth and cash-stock variables do provide additional information, which could either be capturing expectations of profitability at longer horizons, or reflect misspecification of the basic Q model. Results for subsamples do not suggest financing constraints as a likely explanation for these findings. Technical Appendix 1 to accompany Working Paper no. 222 Full text (224k)Technical Appendix 2 to accompany Working Paper no. 222 Full text (228k)"--Bank of England web site.
Notes: Also available in print.
Includes bibliographical references.
Title from PDF file as viewed on 4/13/2005.
System requirements: Adobe Acrobat Reader.
Mode of access: World Wide Web.