The roles of expected profitability, Tobin's Q and cash flow in econometric models of company investment
By Stephen Bond, Alexander Klemm, M. Syed, Rain Newton-Smith, Gertjan W. Vlieghe. 2004
155 citations recorded by the source corpus.
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.
Subfields: Accounting, Finance, Strategy and Management
View Paper: https://www.semanticscholar.org/paper/4e8d9ea8e5ed444c977f6d78398c8dd6cb456881
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Citations in the corpus
- The effects of financialization on investment: evidence from firm-level data for the UK (2018, background): “Possible mainstream explanations focused on the bias of the stock market evaluation due to asymmetric information (Stiglitz and Weiss, 1981) and periodic ‘financial bubbles’ (Bond and Cummins, 2001; Bond et al., 2004).”
- Uncertainty and Investment Dynamics (2006, unknown): “…either (cid:133)nancing constraints (see Fazzari, Hubbard and Petersen (1988)), expectations of future demand growth or pro(cid:133)tability (see Bond et al. (2004)), or more generally measurement errors or mis-speci(cid:133)cations (see, for example, Erickson and Whited (2000) and Cooper and…”
- Economic policy uncertainty and firm-level investment (2014, unknown): “It may be due, as Bond et al. (2004) argue, to expectations of future sales growth or profitability.”