Investment, Tobin's q, and Interest Rates

Xioaji Lin, Chong Wang, Neng Wang, Jinqiang Yang

NBER Working Paper No. 19327
Issued in August 2013, Revised in November 2018
NBER Program(s):Asset Pricing, Economic Fluctuations and Growth

We study the impact of stochastic interest rates and capital illiquidity on investment and firm value by incorporating a widely used arbitrage-free term structure model of interest rates into a standard q theoretic framework. Our generalized q model informs us to use corporate credit-risk information to predict investments when empirical measurement issues of Tobin’s average q are significant (e.g., equity is much more likely to be mis-priced than debt), as in Philippon (2009). We find, consistent with our theory, that credit spreads and bond q have significant predictive powers on micro-level and aggregate investments corroborating the recent empirical work of Gilchrist and Zakrajšek (2012). We also show that the quantitative effects of the stochastic interest rates and capital illiquidity on investment, Tobin’s average q, the duration and user cost of capital, and the value of growth opportunities are substantial. These findings are particularly important in today’s low interest rate environment.

Acknowledgments

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Document Object Identifier (DOI): 10.3386/w19327

forthcoming in the Journal of Financial Economics

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