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Financial Frictions Investment and Tobin's q

Guido Lorenzoni

Northwestern University; National Bureau of Economic Research (NBER)

Karl Walentin

Sveriges Riksbank

April 25, 2007

MIT Department of Economics Working Paper No. 07-16

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.

Number of Pages in PDF File: 33

Keywords: Financial constraints, investment, Tobin's q, limited enforcement.

JEL Classification: E22, E30, E44, G30

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Date posted: April 30, 2007  

Suggested Citation

Lorenzoni, Guido and Walentin, Karl, Financial Frictions Investment and Tobin's q (April 25, 2007). MIT Department of Economics Working Paper No. 07-16. Available at SSRN: http://ssrn.com/abstract=983421 or http://dx.doi.org/10.2139/ssrn.983421

Contact Information

Guido Lorenzoni (Contact Author)
Northwestern University ( email )
2001 Sheridan Road
Evanston, IL 60208
United States
National Bureau of Economic Research (NBER) ( email )
1050 Massachusetts Avenue
Cambridge, MA 02138
United States
Karl Walentin
Sveriges Riksbank ( email )
Brunkebergstorg 11
SE-103 37 Stockholm
HOME PAGE: http://www.riksbank.com/research/walentin

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References:  28
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