Financial Frictions, Investment and Tobin's q

Guido Lorenzoni, Karl Walentin

NBER Working Paper No. 13092
Issued in May 2007
NBER Program(s):   CF   EFG

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.

(354 K)

This paper is available as PDF (354 K) or via email.

Acknowledgments

Machine-readable bibliographic record - MARC, RIS, BibTeX