The Roles of Expected Profitability, Tobin's Q and Cash Flow in Econometric Models of Company Investment

Bond, Stephen; Klemm, Alexander; Newton-Smith, Rain; Syed, Murtaza; Vlieghe, Gertjan

doi:10.2139/ssrn.641241

Cited by 35 publications

(42 citation statements)

References 20 publications

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“…We deal with an unbalanced panel data of firms, and given the dynamic structure of equation (23), we use the system GMM estimator approach as Bond et al (2004), Blundell, Bond, and Windmeijer (2000), and Blundell and Bond (1998). This method controls for the presence of the unobserved firm-specific effect and for the endogeneity of contemporaneous regressors.…”

Section: Model Estimationmentioning

confidence: 99%

Does employment protection legislation affect firm investment? The European case

2014

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This paper aims at analyzing the impact of Employment Protection Legislation (EPL) on firm's investment policy in the presence of financial imperfections. Our results show a negative correlation between EPL levels and investments. Firms facing negative shocks see their financial constraints worsening in countries with greater labour market rigidities. The presence of stricter EPL disincentives the use of internal funds for financing new projects: i.e., if capital is largely sunk and the legal environment favors ex-post profit appropriation by workers, firms may use internal funds for any ends alternative to fixed investment. Our results support the effort put forward by European institutions to reform both markets in recent years.

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Section: Model Estimationmentioning

confidence: 99%

Does employment protection legislation affect firm investment? The European case

2014

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“…In order to describe the optimality conditions of the model, we use equation (9) to substitute d t in the value function (11). Let µ t , λ t and φ t be the Lagrangian multipliers associated respectively with the irreversibility constraint (3), the borrowing constraint (5) and the non-negativity constraint on dividends (6).…”

Section: The Modelmentioning

confidence: 99%

“…In particular Erickson and Whited (2000) and Bond et al (2004) show that errors in measuring the expected profitability of firms explain most of the observed positive correlation between fixed investment and cash flow. Moreover, Gomes (2001), Pratap (2003) and Moyen (2004) simulate industries with heterogeneous firms who may face financing frictions.…”

Section: Introductionmentioning

confidence: 98%

Testing Financing Constraints on Firm Investment using Variable Capital

Caggese

2006

SSRN Journal

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We consider a dynamic multifactor model of investment with financing imperfections, adjustment costs and fixed and variable capital. We use the model to derive a test of financing constraints based on a reduced form variable capital equation. Simulation results show that this test correctly identifies financially constrained firms even when the estimation of firms' investment opportunities is very noisy. In addition, the test is well specified in the presence of both concave and convex adjustment costs of fixed capital. We confirm empirically the validity of this test on a sample of small Italian manufacturing companies. I IntroductionIn order to explain the aggregate behavior of investment and production, it is necessary to understand the factors that affect investment at firm level. Financing imperfections may prevent firms from accessing external finance and make them unable to invest unless internal finance is available. It is therefore important to study the extent to which financing constraints matter for firms' investment decisions. This line of inquiry is also relevant for other areas of research, such as the literature on the role of internal capital markets and banks, as well as the macro literature on the financial accelerator.Starting with Fazzari, Hubbard and Petersen (1988), several studies investigate the presence of financing constraints by estimating the Q model of investment with cash flow included as an explanatory variable. 1 They argue informally that under certain conditions, and in the absence of financing frictions, Tobin's average Q is equal to marginal q, and is a sufficient statistic for firm investment (Hayashi, 1982). It follows that, conditional on Q, cash flow should affect only the investment of financially constrained firms.The motivation for this paper is that recent studies, starting with Zingales (1997 and, have shown that the correlation between fixed investment and cash flow is not a good indicator of the intensity of firm financing constraints. In particular Erickson and Whited (2000) and Bond et al (2004) show that errors in measuring the expected profitability of firms explain most of the observed positive correlation between fixed investment and cash flow. Moreover, Gomes (2001), Pratap (2003) and Moyen (2004) simulate industries with heterogeneous firms who may face financing frictions. They show that the correlation between fixed investment and cash flow may be positive for financially unconstrained firms, and even larger than that of financially constrained firms. 2 Finally, Caballero and Leahy (1996) show that the failure of the investment -cash flow correlation as a measure of financing constraints may be caused not only by the measurement error in Q, but also by misspecification and omitted variable problems.The objective of this paper is to develop a new financing constraints test that is robust to 1 See Hubbard (1998) for a review of this literature. 2 Alti (2003) and Abel and Eberly (2003) and (2004) develop theoretical frameworks in which positive inve...

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“…This is scaled by an estimate of the replacement cost value of the net capital stock at the start of the period, constructed using a simple perpetual inventory formula with an assumed depreciation rate of 8% (see Bond et al (2004) …”

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“…35 As noted by Hayashi (1985) and emphasised by Fazzari, Hubbard and Petersen (1988), investment also displays 'excess sensitivity'to cash ‡ow in a constrained regime of the standard new view or pecking order model. See Bond and Cummins (2001) and Bond et al (2004) for recent evidence on investment-cash ‡ow sensitivity in samples of quoted US and UK companies.…”

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Dissecting dividend decisions: some clues about the effects of dividend taxation from recent UK reforms

Bond¹,

Devereux²,

Klemm³

2005

Working Paper Series

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We present empirical evidence which suggests that a big increase in dividend taxation for UK pension funds in July 1997 a¤ected the form in which some UK companies chose to make dividend payments, but otherwise had limited e¤ects on both the level of dividend payments and the level of investment. These …ndings are consistent with a version of the 'new view' of dividend taxation. We also identify a group of …rms whose dividend choices are di¢ cult to reconcile with (stock market) value maximisation.Acknowledgement: This paper is part of the research of the Large Business Tax Programme at the Institute for Fiscal Studies, supported by the Hundred Group, the Inland Revenue, and the ESRC Centre for Public Policy. We thank Alan Auerbach, Tim Besley, Roger Gordon, Jim Hines, Stephen Matthews, Jim Poterba, Joel Slemrod, David Ulph and participants in seminars at the ESRC Public Economics Working Group, IFS, IMF, the Inland Revenue, University of Manchester, University of Michigan, University College London and University of Warwick for helpful comments. Non-technical SummaryIn this paper we use data for a sample of 696 quoted non-financial UK companies to investigate empirically whether any changes in dividend or investment behaviour can be detected following the abolition of repayable dividend tax credits for UK pension providers in July 1997.This tax reform was intended to have a significant impact on the dividend decisions and investment spending of UK companies. More specifically, it was intended to reduce pressure from pension funds for UK firms to pay out a high share of their profits in the form of dividends, and thereby to allow firms to increase their investment spending.The tax treatment of dividends paid to UK pension funds before 1997 was certainly not neutral, and was unusual in that for these institutional investors there was a more favorable tax treatment of dividend income than capital gains. To what extent this affected company dividend decisions is far from clear, however, for two quite different reasons.First, given that some other investors (e.g. higher rate taxpayers) had a more favorable tax treatment of capital gains than dividends, while others (e.g. basic rate taxpayers and some foreign institutions) had no tax preference, the influence that UK pension funds could exercise over company dividend policies is uncertain.Second, even if UK pension funds were influential, it is unclear whether their tax preference for dividend income would affect dividend payments. That is, if other non-tax costs associated with issuing equity are sufficiently important that retained profits were still the cheapest source of finance for UK companies in the period before 1997, it is entirely possible that the abolition of repayable dividend tax credits for UK pension funds would have had no effect on the level of dividends. This is the prediction of a version of the so-called 'new view' of dividend taxation, which in essence says that if issuing equity is a more expensive source of finance than retaining profi...

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The Roles of Expected Profitability, Tobin's Q and Cash Flow in Econometric Models of Company Investment

Cited by 35 publications

References 20 publications

Does employment protection legislation affect firm investment? The European case

Does employment protection legislation affect firm investment? The European case

Testing Financing Constraints on Firm Investment using Variable Capital

Dissecting dividend decisions: some clues about the effects of dividend taxation from recent UK reforms

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