Working Paper

Tobin's Q, economic rents, and the optimal stock of capital

Abstract: Within optimal investment programs, the accumulation of capital is a stable function of marginal q. Much of the interest in q, however, derives from its potential to reflect the demand for capital when the optimal program changes. If the marginal return on capital diminishes as capital increases, the correspondence between marginal q and the optimal stock of capital can shift whenever investors alter their assessments of prospective economic rents. At such times, marginal q even could rise as the optimal stock of capital falls. In general, robust investment functions express optimal investment in terms of those variables that determine marginal q, rather than marginal q itself. However, under some restrictions (e.g. price-taking enterprises), marginal q may be sufficient to determine the optimal accumulation of capital even as the program changes. The conditions that make marginal q a sufficient statistic also make q a sufficient statistic.

Keywords: Capital;

Bibliographic Information

Provider: Federal Reserve Bank of Boston

Part of Series: Working Papers

Publication Date: 1995

Number: 95-4