What Can We Learn About Investment and Capital Structure with a Better Measure of Q?

50 Pages Posted: 15 Dec 2002

See all articles by William M. Gentry

William M. Gentry

Williams College - Department of Economics

Christopher J. Mayer

Columbia Business School - Finance and Economics; National Bureau of Economic Research (NBER)

Date Written: December 2002


This paper takes an integrated approach to examining the link between stock prices, investment, and capital structure decisions using data on a unique type of firm: Real Estate Investment Trusts (REITs). By using REITs, we are able to obtain high quality estimates of the net asset value of the firm, that can be used to create relatively accurate measures of Tobin's q. In addition, REITs have institutional features that allow us to abstract from other factors that have complicated previous studies. We have three main findings. First, while REIT investment is weakly related to the traditional measure of q, it is quite responsive to an alternative measure of q based on NAV. A REIT whose NAV-based q ratio rises from 1.0 to 1.1 will increase its assets by ten percent in the next year. Second, the debt-to-value ratio responds to deviations in price-to-NAV ratio as well, but more sluggishly. A 0.1 increase in price-to-NAV ratio leads to a relatively modest 0.52 percentage point decrease in the following year's debt-to-market-value ratio. Overall, REITs appear to finance marginal projects with a mix of debt and equity that is similar to their average debt-equity mix. Third, we find evidence that these relationships are nonlinear. Firms invest aggressively when q exceeds one, but do not dis-invest when q is below one. The investment results support traditional theories of firm investment with adjustment costs and imply that past difficulties in validating q theory are likely due to problems in adequately measuring q. The nonlinear relationship between investment and q is consistent with relatively high costs of disinvestment, but also agency models in which managers are reluctant to shrink the size of the firm. Finally, the evidence is weakly consistent with REIT managers attempting a limited amount of financial market timing based on quasi-public information on NAV.

Suggested Citation

Gentry, William M. and Mayer, Christopher J., What Can We Learn About Investment and Capital Structure with a Better Measure of Q? (December 2002). AFA 2003 Washington, DC Meetings. Available at SSRN: https://ssrn.com/abstract=342701 or http://dx.doi.org/10.2139/ssrn.342701

William M. Gentry (Contact Author)

Williams College - Department of Economics ( email )

Fernald House
Williamstown, MA 01267
United States
413-597-4257 (Phone)
413-597-4045 (Fax)

Christopher J. Mayer

Columbia Business School - Finance and Economics ( email )

3022 Broadway
New York, NY 10027
United States

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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