Investment, Tobin's q, and Interest Rates
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Authors
Wang, Chong
Wang, Neng
Yang, Jinqiang
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2013-08
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Abstract
The interest rate is a key determinant of firm investment. We integrate a widely used term structure
model of interest rates, CIR (Cox, Ingersoll, and Ross (1985)), with the q theory of investment (Hayashi
(1982) and Abel and Eberly (1994)). We show that stochastic interest rates have significant effects
on investment and firm value because capital is medium/long lived. Capital adjustment costs have
a first-order effect on investment and firm value. We use duration to measure the interest rate sensitivity
of firm value, decompose a firm into assets in place and growth opportunities, and value each component.
By extending the model to allow for endogenous capital liquidation, we find that the liquidation option
provides a valuable protection against the increase of interest rates. We further generalize the model
to incorporate asymmetric adjustment costs, a price wedge between purchasing and selling capital,
fixed investment costs, and irreversibility. We find that inaction is often optimal for an empirically
relevant range of interest rates for firms facing fixed costs or price wedges. Finally, marginal q is equal
to average q in our stochastic interest rate settings, including one with serially correlated productivity
shocks.
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Article
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NBER Working Paper No. 19327
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Graduate School of Business & Public Policy (GSBPP)
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This publication is a work of the U.S. Government as defined in Title 17, United States Code, Section 101. Copyright protection is not available for this work in the United States.