Financial frictions investment and Tobin's q
By: Guido Lorenzoni [and] Karl Walentin
Contributors: Walentin, Karl; Massachusetts Institute of Technology. Dept. of Economics
Series: Working paper series / Massachusetts Institute of Technology, Dept. of Economics -- working paper 07-16; Working paper (Massachusetts Institute of Technology. Dept. of Economics) -- no. 07-16.
Publisher: Massachusetts Institute of Technology, Dept. of Economics
Published: 2007
Place of publication: Cambridge, MA
Language: eng
Number of pages: 31
Description: 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, generate realistic correlations between investment, q, and cash flow. Keywords: Financial constraints, investment, Tobin's q, limited enforcement. JEL Classifications: E22, E30, E44, G30.
Notes: "April 25, 2007."

Includes bibliographical references (p. 30-31).

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