A Unified theory of Tobins Q, Corporate Investment, Financing and Risk

Management by Patrick Bolton, Hui Chen and Neng Wang

Application:
This research paper only looks at risk management from the shareholders
perspective.
However, the application of Tobins to this research paper is vindicated by the
inference that how in the presence of external financing and payout costs the firms
optimal investment, financing and risk management policies are all interconnected.
The firms optimal cash inventory policy takes the form of a double-barrier policy
where the firm raises new funds only when its cash inventory is entirely depleted,
and pays out cash to shareholders only when its cash-capital ratio hits an
endogenous upper barrier.
In between these two barriers, the firm continuously adjusts its investment to take
account of positive or negative cash-flow shocks.
In addition the firm also hedges its earnings risk by investing in financial assets
that are not perfectly correlated with its underlying business risk.
The benefit of such hedges is to reduce the volatility of the firms cash inventory.

Example:
We find an inverse relation between marginal Tobins q and investment when the
firm draws on its credit line. We also find that financially constrained firms may
have a lower equity beta in equilibrium because these firms tend to hold higher
precautionary cash inventories.