Non-linear response of firm investment to q: Evidence from Greek listed firms

Christos Kallandranis

doi:10.22495/rgcv9i1p5

Abstract

A dynamic-panel model is applied in order to empirically investigate the relationship between business fixed investment and Tobin’s q for the firms listed in the Athens Stock Exchange (ASE). In particular, we search for non-linearities in the underlying relationship between investment and fundamentals, consistent with the presence of multiple regimes. The empirical results support a discontinuity identifying two-regimes: (a) wherein the first (for values of q below a certain threshold) investment is inelastic to q, while in the second it exhibits a positive relationship, and b) a further non-linearity expressed in a concavity of the investment- q relationship implying that for the segment where investment reacts to fundamentals positively, it does so at a decreasing rate evidence which is consistent with the presence of non-convexities in adjustment costs

Highlights

Investment can be considered as one of the main components of aggregate demand since it plays a central role in both the cyclical and long-run performance of any economy
The empirical results support a discontinuity identifying two-regimes: (a) wherein the first investment is inelastic to q, while in the second it exhibits a positive relationship, and b) a further non-linearity expressed in a concavity of the investment- q relationship implying that for the segment where investment reacts to fundamentals positively, it does so at a decreasing rate evidence which is consistent with the presence of non-convexities in adjustment costs
Many empirical studies of investment reject this implication by finding that cash flow has a significant effect on investment, even if q is included as an explanatory variable

Summary

Introduction

Investment can be considered as one of the main components of aggregate demand since it plays a central role in both the cyclical and long-run performance of any economy. Most of the econometric models of investment applied to firm-level data in many empirical studies may be viewed as special cases of a general factor demand model. In most of these studies capital input is assumed to be homogeneous and treated as the only quasi-fixed factor used by the firm. The intuition behind Tobin’s q model is that absent considerations of taxes or capital market imperfections, a valuemaximizing firm will invest as long as the shadow value of an additional unit of capital (marginal q) exceeds unity. Tobin’s suggestion was that a firm’s investment decision should be related to the market value of the firm’s capital compared to its replacement cost. Under the assumptions of constant returns to scale, strictly convex costs of adjusting the capital stock and investment reversibility, it is ensured that investment is a linear function of fundamentals (Mussa, 1977; Abel, 1983)

Methods

Results

Conclusion