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Measurement Error and the Relationship between Investment and q

31 Pages Posted: 31 Oct 2000  

Timothy Erickson

U.S. Department of Labor - Bureau of Labor Statistics

Toni M. Whited

University of Michigan, Stephen M. Ross School of Business; National Bureau of Economic Research

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Abstract

Many recent empirical investment studies have found that the investment of financially constrained firms responds strongly to cash flow. Paralleling these findings is the disappointing performance of the q theory of investment: even though marginal q should summarize the effects of all factors relevant to the investment decision, cash flow still matters. We examine whether this failure is due to error in measuring marginal q. Using measurement error-consistent generalized method of moments estimators, we find that most of the stylized facts produced by investment-q cash flow regressions are artifacts of measurement error. Cash flow does not matter, even for financially constrained firms, and despite its simple structure, q theory has good explanatory power once purged of measurement error.

Suggested Citation

Erickson, Timothy and Whited, Toni M., Measurement Error and the Relationship between Investment and q. Available at SSRN: https://ssrn.com/abstract=284428 or http://dx.doi.org/10.2139/ssrn.284428

Timothy Erickson

U.S. Department of Labor - Bureau of Labor Statistics ( email )

2 Massachusetts Avenue, NE
Postal Square Building, Room 3105
Washington, DC 20212
United States
202-691-6575 (Phone)
202-691-6583 (Fax)

Toni M. Whited (Contact Author)

University of Michigan, Stephen M. Ross School of Business ( email )

701 Tappan Street
Ann Arbor, MI MI 48109
United States

National Bureau of Economic Research ( email )

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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