Working Paper

Exhuming Q: market power capital market imperfections

Abstract: Evidence of the statistical significance of profits in Q regressions remains one of the principal findings in the empirical investment literature. This result is frequently taken to support the view that capital market imperfections are an important element for understanding investment. This paper challenges that conclusion. We argue that allowing the profit function at the firm level to be strictly concave, reflecting, for example, market power, is sufficient to replicate the Q theory based regression results in which profits are a significant factor determining investment. To be clear, our ability to replicate the existing results does not require the specification of any capital market imperfections. Thus the friction that explains the statistical significance of profits could be market power by sellers rather than capital market imperfections.

Keywords: Capital investments; Corporate profits; Regression analysis;

Bibliographic Information

Provider: Federal Reserve Bank of Minneapolis

Part of Series: Working Papers

Publication Date: 2001

Number: 611