How Do Frictions Affect Corporate Investment? A Structural Approach

Abstract

This paper provides a structural approach to test investment equations based on the log-likelihood function of a non-linear investment rule. The analysis integrates the predictions of the q-theory for the commonly studied active region of investment, and provides new inferences on how real and financing frictions affect the probability that a firm invests. Our empirical findings are consistent with the macro-finance literature suggesting that q-theory models with non-convex investment frictions better explain the data. We also find that both real and financing costs of investment are related to the capital intensity of the industry in which firms operate.

Keywords: Tobin's Q, financing frictions, real frictions, investment, log likelihood

JEL Classification: E22, G31, G32