Financial Frictions, Investment, And Tobin'S Q

A model of investment with financial constraints is used to study the relation between investment and Tobin's q. A firm is financed by both inside and outside investors. When insiders' wealth is scarce, the firm's value includes a quasi-rent on invested capital. Therefore, two forces drive q: the value of invested capital and future quasi-rents. Relative to a frictionless benchmark, this weakens the relationship between investment and q, generating more realistic correlations between investment, q, and cash flow. The quantitative implications of the model for investment regressions depend crucially on the nature of the shocks hitting the firm. (C) 2018 Elsevier B.V. All rights reserved.