The roles of expected profitability, Tobin's Q and cash flow in econometric models of company investment.
Evidence that cash flow has a significant effect on company investment spending, after controlling for Tobin's average Q, has often been interpreted as suggesting the importance of financing constraints. Recent work on measurement error in the Q model casts doubt on this interpretation. It is p...
| Main Authors: | , , , , |
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| Format: | Working paper |
| Language: | English |
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Institute for Fiscal Studies
2004
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| _version_ | 1826257295588196352 |
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| author | Bond, S Klemm, A Smith, R Syed, M Vlieghe, G |
| author_facet | Bond, S Klemm, A Smith, R Syed, M Vlieghe, G |
| author_sort | Bond, S |
| collection | OXFORD |
| description | Evidence that cash flow has a significant effect on company investment spending, after controlling for Tobin's average Q, has often been interpreted as suggesting the importance of financing constraints. Recent work on measurement error in the Q model casts doubt on this interpretation. It is possible that the Q model may not be identified if there are 'bubbles' in stock market valuations that are both persistent over time and that are correlated with fundamental values. Cash flow may then provide additional information about expected profitability that is not captured by a poorly measured Tobin's average Q variable. We explore this hypothesis empirically using UK panel data on companies for which analysts' earnings forecasts are available from the IBES database. The results point to a severe measurement error in average Q. The paper finds that, controlling for expected profitability using analysts' earnings forecasts, cash flow becomes insignificant. Both sales growth and cash-stock variables do provide additional information, which could either be capturing expectations of profitability at longer horizons, or reflect misspecification of the basic Q model. Results for subsamples do not suggest financing constraints as a likely explanation for these findings. |
| first_indexed | 2024-03-06T18:15:54Z |
| format | Working paper |
| id | oxford-uuid:049cee09-0418-4816-8bcb-7c95fe5f05b7 |
| institution | University of Oxford |
| language | English |
| last_indexed | 2024-03-06T18:15:54Z |
| publishDate | 2004 |
| publisher | Institute for Fiscal Studies |
| record_format | dspace |
| spelling | oxford-uuid:049cee09-0418-4816-8bcb-7c95fe5f05b72022-03-26T08:52:42ZThe roles of expected profitability, Tobin's Q and cash flow in econometric models of company investment.Working paperhttp://purl.org/coar/resource_type/c_8042uuid:049cee09-0418-4816-8bcb-7c95fe5f05b7EnglishDepartment of Economics - ePrintsInstitute for Fiscal Studies2004Bond, SKlemm, ASmith, RSyed, MVlieghe, GEvidence that cash flow has a significant effect on company investment spending, after controlling for Tobin's average Q, has often been interpreted as suggesting the importance of financing constraints. Recent work on measurement error in the Q model casts doubt on this interpretation. It is possible that the Q model may not be identified if there are 'bubbles' in stock market valuations that are both persistent over time and that are correlated with fundamental values. Cash flow may then provide additional information about expected profitability that is not captured by a poorly measured Tobin's average Q variable. We explore this hypothesis empirically using UK panel data on companies for which analysts' earnings forecasts are available from the IBES database. The results point to a severe measurement error in average Q. The paper finds that, controlling for expected profitability using analysts' earnings forecasts, cash flow becomes insignificant. Both sales growth and cash-stock variables do provide additional information, which could either be capturing expectations of profitability at longer horizons, or reflect misspecification of the basic Q model. Results for subsamples do not suggest financing constraints as a likely explanation for these findings. |
| spellingShingle | Bond, S Klemm, A Smith, R Syed, M Vlieghe, G The roles of expected profitability, Tobin's Q and cash flow in econometric models of company investment. |
| title | The roles of expected profitability, Tobin's Q and cash flow in econometric models of company investment. |
| title_full | The roles of expected profitability, Tobin's Q and cash flow in econometric models of company investment. |
| title_fullStr | The roles of expected profitability, Tobin's Q and cash flow in econometric models of company investment. |
| title_full_unstemmed | The roles of expected profitability, Tobin's Q and cash flow in econometric models of company investment. |
| title_short | The roles of expected profitability, Tobin's Q and cash flow in econometric models of company investment. |
| title_sort | roles of expected profitability tobin s q and cash flow in econometric models of company investment |
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