NATIONAL BUREAU OF ECONOMIC RESEARCH
NATIONAL BUREAU OF ECONOMIC RESEARCH

Exhuming Q: Market Power vs. Capital Market Imperfections

Russell Cooper, Joao Ejarque

NBER Working Paper No. 8182
Issued in March 2001
NBER Program(s):   EFG

Evidence of the statistical significance of profits in Q regressions remains one of the principal findings in the empirical investment literature. This result is frequently taken to support the view that capital market imperfections are an important element for understanding investment. This paper challenges that conclusion. We argue that allowing the profit function at the firm level to be strictly concave, reflecting, for example, market power, is sucent to replicate the Q theory based regression results in which profits are a significant factor determining investment. To be clear, our ability to replicate the existing results does not require the specification of any capital market imperfections. Thus the friction that explains the statistical significance of profits could be market power by sellers rather than capital market imperfections.

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