This action might not be possible to undo. Are you sure you want to continue?

—

—

—

—

— —

—

—

—

—

—

—

•

—

—

—

—

—

—

—

•

— —

— •

—

—

—

—

—

—

— —

—

—

—

—

— —

—

— — — — —

•

—

— — — — —

—

—

—

— — — —

— —

— — —

—

— — —

—

— —

—

•

—

—

— — —

—

•

— —

— — — — —

— — — — —

— — —

•

— —

— — — —

•

— — • —

— —

—

• •

— —

— —

—

—

—

—

— — — — —

— •

— —

—

— — — — — — —

— —

— — —

—

— — — —

— — — — — — — — — — — — —

•

•

— —

— —

•

—

—

•

—

— • —

— — —

—

— — —

— — — — —

— — —

NBER Working Paper #2033 October 1986

Investment, Tobin's Q, and Multiple Capital Inputs

ABSTRACT

Despite

**their solid theoretical basis, models of business
**

theory

investment based on Tobin's Q

have recorded a generally

This paper examines one possible source of misspecification. When the firm's technology is expanded to include two or more capital inputs, the investment

disappointing empirical performance.

equation following from maximizing behavior includes Q as well as a series of additional explanatory variables. The importance of these

**omitted variables is assessed, and the econometric evidence is mixed,
**

as the Multi-Capital Q

model

clearly dominates the Conventional

**In addition, the implications of the parameter estimates from the Conventional and
**

specification but empirical problems remain.

Multi-Capital models for tax policy are noted.

Robert

S. Chirinko Committee on Policy Studies 1050 East 59th Street University of Chicago Chicago, IL 60637

INVESTMENT. TOBIN'S Q. AND MULTIPLE CAPITAL INPUTS

I. INTRODUCTION

Quantifying the parameters characterizing the capital accumulation process has been the subject of economic research for a

number of years. A substantial amount of our knowledge of this process is based on estimates of the "Neoclassical" investment model

pioneered by Dale Jorgenson (1963). While this econometric specification is capable of explaining a substantial amount of the

**variation in investment expenditures, it has been criticized for a lack
**

of careful consideration of dynamics arising from expectations (Lucas, 1976) and intertemporal aspects of the technology (Nerlove,

1972).

**The Q theory approach to investment behavior, introduced by
**

Keynes (1964) and revitalized by James Tobin (1969), offers possible solutions to these two shortcomings. In this model, a forwardlooking firm faced with costs in adjusting its capital stock will have

its investment expenditures determined by marginal Q, the ratio of the discounted future revenues from an additional unit of capital to the net-of-tax purchase price. Whenever this ratio differs from unity, the firm has an incentive to alter its capital stock, but its

actions are tempered by the adjustment cost technology.

Since

marginal Q is unobservable, empirical models have utilized average Q, defined as the ratio of the value of the firm, as evaluated in financial markets, to the replacement cost of its existing capital stock.

By relying on financial market data, which in principle incorporates expectations of future variables relevant to the investment decision,

2

Q models

provide a direct role for expectations in the econometric

specification.

The problem of unobservable expectations has received a great

deal of attention in the applied econometrics literature, and an alternative approach uses time-invariant, forecasting equations to calculate marginal Q. This class of solutions includes the two-step

procedure of Abel and Blanchard (1984), the maximum likelihood

estimator of Hansen and Sargent (1980), and the Euler equation technique of Hansen and Singleton (1982); in the latter case, the forecasting equations are determined by the choice of instruments. These methods arose in response to the critique of Lucas (1976), who

argued that "any change in policy will systematically alter the structure of econometric models" (p. 41). Under this view, changes in

policy are identified as changes in the parameters governing policy outcomes, and these parameters will generally affect forecasts of economic variables. Only if one maintains that the sample period

contains no changes in policy or non-policy factors affecting the

**stochastic environment will the forecasting solutions to the
**

unobservable expectations problem be valid.

of the Q approach period is characterized by an unstable stochastic environoment.

A significant advantage is that estimation can proceed even if the sample

However, the usefulness of Q theory is called into question by its generally disappointing empirical performance.1 A number of the problems associated with empirical Q models are evident in the

1 See Chirinko (1986, Section V.B.3) for a review of the econometric results from Q models, and Clark (1979) for simulations comparing Q to other investment models.

who found that investment responded unreasonably slowly to variations in (t). steady-state value. and inventories. the lagged dependent 2 When constrained by a geometric lag distribution.477 Res Sum Sq = . His simulations indicated that. p.5020 Sample Period: 1950-1978 where 1(t) and K(t) are the investment flow and capital stock.256 m = 3.368 I(t-1) / K(t) (1) (. . p.190) = . the econometric estimates of Ciccolo (1975) imply that the mean lag of the adjustment to a change in the long-run capital stock is seven years (Hall.013 (t) / K(t) + . 101). the capital stock would have moved only three-fourths of the way to its ultimate. structures.021) (. for the three capital goods and c (t) is a variable closely related to average Q (to be discussed below).072 + . 89). respectively.005) (. 1977. twenty years after an unexpected change in the economic environment.013 is smaller than that obtained in the Q study of Summers (1981. The coefficient of .3 following investment equation estimated with aggregate data for equipment. 1(t) / K(t) = .2 Contrary to the theory.

indicating that the capital homogeneity assumption implicit in the conventional Q model may be inappropriate. the central idea to be exploited in this study is that conventional formulations of empirical Q models are misspecified by failing to recognize the possibility that the value of the firm depends on two or more capital inputs with differing adjustment cost technologies.. the serial correlation patterns for the three capital inputs differ widely. and thus the relation betweeen his result and empirically significant lagged variables is not apparent. he enters lags into the maximization problem by assuming that adjustment costs depend on both current and lagged investment. There are two objections to his result. the investment schedule that follows from his model is quite different from those actually used in econometric work. but it is not at all clear what phenomena are being captured by this formulation. as measured by the mstatistic (cf. A problem thus facing the applied econometrician is that conventional Q theory does not suggest what modifications or additional explanatory variables may be useful in attenuating these deficiencies.4 variable proves an important determinant of investment. structures. and inventories suggests a possible cause of this In Table I. 11). Thus. the R2 is rather low and. disappointing empirical performance. An examination of the investment data for equipment.3 Furthermore. Second. these patterns are consistent with the adjustment cost technology underlying the Q model. Fischer . First. Under the assumption that adjustment costs increase with the durability of the capital asset. fn. 3 That the relationship (1983) has shown that lagged Q should be an important determinant of investment spending. serial correlation in the residuals indicates that the model is misspecified.

and Multi-Capital Q Section III considers specification issues relating to the investment model. Wildasin. In this paper. The simulated responses of investment expenditures and capital accumulation to an unanticipated change in the economic environment are calculated for both models in Section V. show that a structural model can be preserved under a broader specification of the technology. (unobserved) marginal Q.5 between Q and investment is sensitive to the number of capital inputs has been noted previously (Chirinko. 1984). the Conventional are estimated with a variety of econometric techniques. we investigate the specification error due to these omitted variables. A summary and conclusions are provided in Section VI. 1982b. and (observed) average Q. which relates investment expenditures. The theoretical development of the Multi-Capital Q model is contained in Section II. models In Section IV. . and provide econometric evidence to evaluate the Multi-Capital Q model. We give particular attention to the way in which debt finance affects the definition of average Q.

C(t).6 II. T(t). and net financing costs. at time t.VjcJI . are valued in terms .F(t)} dt . and is characterized by constant returns to scale with respect to all inputs and by Inada conditions. These internal costs can be viewed as the movement of real resources from producing output toward installing capital goods. operating costs. The production technology (cI[tJ) depends on labor (L(t)) and J distinctive types of capital (K(t). (3) Operating costs (C(t)) arise from purchasing inputs and adjusting the capital stocks. THE MULTI-CAPITAL Q MODEL . respectively. R(t) = p(t) C1 [L(t). taxes. and F(t) represent revenues. To capture the quasi-fixed nature of capital. we assume that the firm incurs adjustment costs when incorporating new capital goods into the production process. Revenues (R(t)) are generated by selling a single product in a competitive market at an exogenous price (p(t)). jEJ). 00 V(O) = f exp(.THEORY The representative firm chooses variable and quasi-fixed inputs to maximize the present discounted value of its cash flow (V(O)) over an infinite horizon.f p(s) ds) {R(t) o 0 C(t) - T(t) . The firm purchases labor services at price w(t) and new capital (I(t)) at prices v(t) in perfectly competitive factor markets.K(t). (2) where p (s) is the discounting factor at time s and R(t).

K(t)].s) va(s) Ii(s) ds -00 (5) where D(t-s. .s) are tax depreciation allowances per dollar of the jth investment made t-s periods ago according to the tax code in effect in period s. and increase at an increasing rate as investment exceeds replacement needs. equation (5) can be rearranged to isolate those factors that depend on current decisions and those that are predetermined at time t. When embedded in the firm's discounted cash flow expression (2). jEJ (4) An income tax is assessed at rate t(t) against the firms revenues less labor and adjustment costs. t t(t) f D(t-s.7 of the opportunity cost of foregone output. both arguments. and is reduced by tax credits (k3(t)) extended on the purchase of investment goods.K(t)J . The effective cost of the jth capital good is further lowered by tax depreciation allowances granted against current taxes but based on both current and past investments. defined as the product of an exponential depreciation rate () and the existing These properties apply to the adjustment cost functions (F[I(t).VjcJ) that are homogeneous of degree one in capital stock. C(t) w(t) L(t) + jeJ v(t) I(t) + p(t) F[I(t).

-00 (6c) te [0. v(t) jeJ (k(t)+z(t)) I(t) — A3(t. t 0 (6b) A(t. and (6c) represents the total value of tax depreciation allowances claimed at time t on the jth capital asset purchased before time 0. T(t) = t(t) {p(t) D [L(t). 00 (6a) z(t) = f t 5 exp(. excluding those directly associated with debt finance.t) ds .s) vs(s) Ia(s) ds .VjeJ] — w(t) L(t) — p(t) F[I(t). are as follows.0) (7) Net financing costs (F(t)) for the jth type of capital are introduced into the model by augmenting the firm's cash flow to .O) = t(t) f D(t-s. Total taxes (T(t)) paid by the firm.K(t).f p(u) du) er(s) D3(s-t.00) The expression for z(t) represents the present discounted value of current and future tax depreciation allowances flowing from a dollar of investment in period t.O) .K(t)]} jeJ — .8 v(t) (k(t)+z(t)) I(t) + A(t.

and debt is retired at an exponential rate (TI). t (1-t(t)) f i(s) X(s) exp(-TI (t-s)) ds .4 A firm that finances a proportion (b(s)) of its net-of-tax investment with debt will have its cash flow incremented by X(s) = b(s) (l_k(s)-z(s)) vs(s) I(s) . t f Ti X(s) exp(-i1(t-s)) ds . the cash flow devoted to retirements equals the amount of debt issued at time s (X(s)) multiplied by the "survival" factor (exp-rI (t-s)) and the retirement rate (TI). they are multiplied by one less the tax rate at time t. -00 (8b) payments at time t are the product of the amount of debt issued at time s surviving at time t and the interest rate (i(s)) prevailing at time s.9 reflect the acquisition and retirement of debt and net-of-tax interest payments. -00 (8c) This formulation of debt finance follows from joint work with Stephen King (1983). summed from time t backward. and summed from time t backward. In recognition Interest of the deductibility of interest payments against income taxes. (8a) Debt policy is exogenous to this model. In period t. .

Equation (9c) represents the value of the net-of-tax interest and retirement payments at time t on debt acquired prior to time 0 and. would be eliminated. but becomes . then ic(t) becomes unity.O}. F(t) = ic J v(t) (l-k(t)—z(t)) (t) I(t) — B(t.f (p(u)+Tl) du) [(1-t(s)) i(t) + 11] ds} . and rearranged to obtain the following expression for the firm's net financing costs. If financial policy eliminates arbitrage opportunities between the net-of-tax cost of borrowing and the capitalization rate on debt. when discounted by p(t) and integrated from zero to infinity. and the potential advantage of debt financing.oo) Equation (9b) represents the potential subsidy for the purchase of investment goods provided by debt finance.1. t 0 B(t. (9a) v(t) = b(t){{ f exp(. This interpretation holds for any time paths of the variables. arising from the tax deductability of interest payments.10 Equations (8a-c) can be embedded in the firm's discounted cash flow expression (2). becomes the market value of the firm's debt at time 0 (B*(0)). t[O.O) 00 S .O) = (1-t(t)) t (9b) f i(s) X(s) exp(-'r (t-s)) ds -00 + rf -00 0 (9c) X(s) exp(-rl(t-s)) ds.

00 t 0 0 -00 B*(0) = FV(0) where f exp(.f (p(u)÷) du) { f co(s)[(l-t(t))i(s)+TI] ds} dt. If the costs of debt and equity are equated through financial policy. (9). we assume that movements in the capital stocks are governed by the following transition equations. (4). and the face and market values of debt are identical. 0 o(s) is the percentage of the face value of debt issued in period s. and (11) and. are constant from time zero onward. in order to analyze the optimal choices of labor and capital inputs. 0 (lOa) FV(0) = jeJ - f X(s) exp(rs) ds . (7). 'r(t). and p(t). The general expression for the market value of debt is as follows.5 B*(O) = [((l-t(O)) i(O) + 'ri) I (p(O) + TI)] FV(O) . To complete our specification of the cash flow problem facing the firm.11 apparent when we assume i(s). VjcJ (11) The firm is assumed to maximize (2) constrained by (3). K(t) = I(t) — & K(t) . . (lOb) where FV(O) is the face value of debt remaining at time 0. we construct the following current-value Hamiltoni an. then the term in braces in (lOa) is unity.

Necessary conditions for the maximization of (12) are obtained by applying 6 In regard to debt finance. state (K(t)). and (t) is the purchase price of new capital adjusted for the effects of taxes and financing. Second. our formulation differs in two respects from that found in the Q models of Summers (1981) and Poterba and Summers (1983).w(t) L(t) . When the percentage of debt finance is constant (as has been assumed in previous studies). I(t)).O) — B(t.K(t). the specification of the purchase price of new capital allows for the possibility that financial policy may not eliminate the subsidy associated with debt finance.(t)) variables. and thus average Q (or 2 in the current notation) will reflect the time variation in the market value of debt. v(t) = v(t) (l—k(t)-z(t)) (1+'qr(t)) te[0.6 Note that A(t.O) and B(t. our derivation permits the marginal and average levels of debt finance to vary. I(t). K(t). .oo) where (12) is written in terms of the control (L(t). and thus do not affect the firm's profit-maximizing decisions.12 t H [L(t).K(t)] } — v(t) I(t) + t(t) (I(t) je J K(t)) + A(t. VjeJ] = exp(- f p(s) ds) 0 (1 2) {(1-t(t)) {p(t) [L(t). and current-value co-state (p.p(t) je J F[I(t). First.VjeJ} . especially when nominal interest payments are tax deductible.O)} .O) are predetermined in period t. .t(t). it is unlikely that this subsidy will be zero.

equality is given by (13c). These involve the sum of purchase and marginal adjustment costs. (13a) = f t 5 exp(.13 Pontryagin's Maximum Principle and. L[t] = 00 w(t) I p(t) . this marginal benefit must equal the total marginal costs of acquiring capital. VjcJ (13c) (13a) is the familiar marginal productivity condition for a variable factor of production. for purposes of the present analysis. and the requisite depreciation.FKJ[s]} ds (13b) + (l-t(t)) p(t)) F1[tJ . . we consider the following conditions pertaining to labor and the jth type of capital. The marginal benefit of an additional Equation unit of capital is defined in (13b) as the sum of current and future marginal products weighted by the rates of discount and Along the optimal path.f (p(u)+) t du) (1-t(t)) p(t)) {cIKJ[s] .

the firm participates in perfectly competitive output and factor markets. Abel (1979). and Yoshikawa (1980). T 0 Lim exp(. we derive the positive By relationship between investment. the ratio of the shadow price for the jth capital good to its net purchase price. THE MULTI-CAPITAL 0 MODEL . For a firm that uses only equity finance and one capital input. This relationship has been noted by. and marginal Q. Hayashi (1982a) has developed the conditions under which the unobserved shadow price of capital can be related to financial market data. it is of little immediate use in applied work. capital depreciates exponentially.SPECIFICATION The optimizing conditions associated with the maximization of (12) form the basis of the Multi-Capital Q model of investment. 8 The transversality condition is written as follows. as embedded in the adjustment cost function. among others.f p(s) ds) j. dividing both sides of (13c) by v(t). and the discounted values of the capital stocks are constrained by transversality conditions. we obtain the following relationship between shadow prices and financial data.14 III. Sargent (1979).7 Since this equation contains an unobservable variable.i(T) K(T) = T—*oo . VjcJ 0 . These conditions include that the production and adjustment cost technologies exhibit constant returns to scale.8 Modifying Hayashi's proof to incorporate multiple capital goods and debt finance. Mussa (1977).

and the equity value of the firm is determined by the quasi-rents from the stocks available at the beginning of the planning period. under constant returns to scale. assumption of competitive markets ensures that. Assuming momentarily that the firm uses only one capital good and that A*(0) and B*(0) are zero. (l5) . the value of the jth capital good is the product of its shadow price and the existing stock. average Q V(0) / (0) K(0) = j.15 V(O) = ic J (O) K(O) + A*(O) - B*(O) . (14a) 00 A*(O) = f o 00 exp(. (14b) B*(0) = f o exp(. The most important of these is fixed capital and.O) dt. Thus. we see that (14a) delivers the basic relationship between marginal and average Q.O) dt.f p(s) ds) 0 jcJ A(t. the latter defined as the ratio of the financial value of the firm to its replacement cost. after period 0. the marginal and average return to capital are identical. (14c) jeJ The The intuition behind this results is rather straightforward. the firm is unable to earn any profits.f p(s) 0 ds) B(t.t(0) / (O) marginal Q.

F3[I(t). plus the discounted value of tax depreciation allowances due to past investments (A*(O)). we need to impose some assumptions about the intertemporal technology. (14). the equity value depends on the other capital goods and their shadow prices. . \Vhile these lagged variables compromise the structural interpretation of the investment equations. and (16). they are included in the general specification because their statistical significance serves as a test for misspecification in the expanded model. To obtain an investment equation amenable to testing. Combining (13c). Furthermore. and choose the following parameterization of the adjustment cost function s. it would appear preferable to account explicitly for the dynamics rather than doing so implicitly through a GLS correction. less the discounted liability due to past financing committments (B*(O)). past studies have found that lagged variables have been significant in Q investment equations. and As lagged dependent variables are included in the general econometric specification to represent any dynamics not fully captured by (16).16 More generally.K(t)J = (yf2) [I(t)/K(t) — J}2 K(t) VjeJ (16) noted in the introduction. we obtain the following system of investment equations for the J capital goods.

(t) is defined as the difference between the financial value of the firm (adjusted for tax depreciation) and the replacement cost of the capital stocks all deflated by the net-of-tax output price.17 I(t) = K + (1 /y3) f (t) - (Yk'Y) lk(t) (17a) + (Yk• Sk/Yj) Kk(t) + I(t-1) + c(t) . (Note that the same 1 (t) enters all J investment equations and. (t) = {V(t) + B*(t) . 1983). 1982b) or the adjustment cost function (Poterba and Summers.A*(t) jeJ v(t) K(t)} / ((1-t(t)) p(t). market value data will not prove to be a "sufficient statistic" for signaling investment expenditures for any particular capital input. (17b) where the k subscript represents all but the jth capital good and (17) corresponds to the case where J=2. In (17b).kei. if adjustment costs were valued by the price of investment goods An additive error term can be derived from the theoretical model if we assume that technology shocks affect either the production function (Hayashi. in the Multi-Capital Q model.. other than to warn of the omnipresent possibility of correlation between error terms and endogenous regressors (i.e. Vj. Ik(t)). Equations (17) highlight that.9 and is the parameter for the lagged dependent variable. . A white-noise error term (c(t)) reflects non-systematic variations in I(t) and approximation errors that have arisen in the development of the model. The maximization problem has not been formulated with these additional assumptions because neither result in any restrictions on the estimation procedure.

ceteris paribus.) (t) would be replaced by average Q less unity In (17a). the greater the adjustment costs for the kth capital good and. The stronger the association between (t) and investment expenditures for the kth capital good. 1986. Q model may be misspecified. The regressors subscripted by k affect I(t) through adjustment costs. 531). a given value of (t) indicates the profitable The own capital level of investment activity for the entire firm. Insofar as the flow variables are strongly. Kk(t) has a positive effect on investment The failure to include these latter variables in econometric equations implies that conventional formulations of the expenditures. (cf. Since a larger capital stock lowers adjustment costs. (15)). stock influences gross investment positively due to replacement needs. the estimated 7j's from (17).. it has been noted that the large estimated values of are an inevitable outcome of relating volatile financial market data to the less variable investment series (Shapiro.18 rather than output. the fewer resources available for investment in the jth capital good. .10 The econometric results presented in the next section will allow us to assess the extent of this bias and the degree to which the Multi-Capital model attenuates the other empirical problems associated with Q theory. positively correlated with 1 (t). hence. The higher Ik(t). 10 Alternatively. p. the greater the upward bias in Yj. should fall.

However. The length of the sample and the number of capital goods were determined by data availability. Ordinary Least Squares estimates of the Conventional (CV) and Multi-Capital (MC) models are presented in Table II. As assessed by the rn-statistic. rn-statistic is distributed t under the null hypothesis of no The rn-statistic is calculated in a regression of the residuals from an equation with a lagged dependent variable (e. 11 The serial correlation. m is the t-statistic on the lagged residual. Since no estimation technique dominates under even modest violations of maintained assumptions. and serially correlated residuals are absent. 1974). 276). trends in the flow and stock variables (Granger and Newbold. and detailed information concerning data sources is For each capital input.g. Performing a t-test on this coefficient is asymptotically equivalent to the Durbin h-test. For the CV model. (17a) was scaled by K(t) to eliminate the possible spurious correlation arising from the provided in the Glossary. structures. . results are reported for a variety of estimators. the bulk of the explanatory power of the Q model can be traced to the structures equation. and has performed better than the h-statistic in Monte Carlo experiments (Harvey. The results for the MC model are mixed. contrary to a strict interpretation of Q theory. 1981. and inventories. columns 1-3 and 4-6.19 IV. it can be calculated for all possible values of the estimated parameters. the lagged dependent variables in the equipment and structures equations are significant.. ECONOMETRIC RESULTS The Multi-Capital Q model was estimated with data for nonfinancial corporations over the period 1950-1978 for three capital goods . p. respectively. (17a)) on all of the explanatory variables in the initial regression plus the lagged residual.11 the residuals are serially correlated and.equipment. The 2's are improved substantially.

for each of the three investment equations.kEJ. Key to our development of the Multi-Capital Q model is the assumption that the adjustment cost parameters differ among the capital inputs. While a number of the additional flow and stock variables are significant. The tests were conducted for each of the capital goods four different ways: with or without a lagged dependent variable. regardless of which capital good served as the dependent variable. we can interpret the aggregate equation (1) as a restricted case of the separate MC equations (17) and. 13 To ensure that (1) is nested within (17a). most are of the wrong sign.20 However. and for two (equipment and structures) or three (equipment.jEJ. Vk. the zero restrictions on the four additional regressors (Ik(t). The CV specification is nested within the MC and. the rejections o the CV model reported above are strong evidence in favor of the MC specification. is rejected by the data. the restricted model was always rejected at the 1% level. This aggregate Q investment equation stands in contrast to Wildasin's (1984) Proposition II. structures. First. which is based on an aggregate investment equation specified as the ratio of nominal variables. which also contains a significant lagged dependent variable.'2 Second.13 Estimates for the MC model may be biased by correlations between error terms and the investment flows (the capital stocks 12 These results hold whether or not a lagged dependent variable is included as a regressor. Kk(t). the only significant coefficient on c(t) appears in the structures equation. the separate MC equations have all been scaled by the aggregate capital stock instead of K(t) and the constant term in the restricted model is interpreted as a weighted average of the depreciation rates for the separate capital goods. . and inventory) capital goods. and two tests suggest that the null hypothesis -= Yk' Vj. are rejected at the 1% level.

Three-Stage Least For the MC model. dated at the beginning of the period. 14 The instrument list included all of the predetermined variables in the three equation system plus keq(t). these estimates remain essentially unchanged.78. zeq(t). and all of the coefficients on (t) are significant. Not surprisingly. The system of equations characterizing the MC model has 12 regressors not contained in the CV model. t(t). An problem. and 11 of these are statistically significant. the parameter estimates were largely unaffected. t(t). though the coefficient in the equipment equation is negative. Instrumental variables (IV) regressions for the MC model are presented in columns 4-6 of Table III and. Coefficients on the lagged dependent variables and tests for serially correlated residuals are both insignificant. Squares (3SLS) estimates are presented in Table IV. distributed X2(12). and can conduct an additional test of the specification. relative to OLS. . and Table III contains two sets of estimates that avoid this potential Reduced form estimates are contained in the first three columns. are predetermined).14 By recognizing the contemporaneous correlation between the cs we can enhance the efficiency of the coefficient estimates. all of the coefficients on Q(t) are significant at the 1% level. and all predetermined variables in a given equation.21 and (t). The R2's for the first-stage regressions were no lower than . 4 of which are of the correct sign. When the instrument list was reduced to keq(t). a comparison of the CV and MC models based on the differences in their Criteria. zeq(t). a prediction borne-out by the estimates. implication of the adjustment cost technology is that these coefficients should be lowest for structures (representing the largest adjustment costs) and highest for inventories.

indicating that the null hypothesis of no misspecification can not be To gain additional insight into the MC model.372 (P > rejected. 15 . and the coefficients on the lagged dependent variables increase sharply. The test statistic was computed with the 3SLS residual covariance matrix. For the three equation system. In comparing the IV and 3SLS estimates. a comparison of the Criteria for the This statistic is based on the IV estimates in Table III. the 3SLS estimates will differ substantially from the corresponding IV estimates. columns 4-6. Since inventories play an important role in buffering the firm against shocks. the HDW test statistic is distributed 2(21). which has been excluded in a number of previous Q studies. These inventory terms are removed in the regressions reported in columns 5-6. and the results change little for the CV model (columns 1-2) or for the MC model when the inventory terms remain as regressors (columns 3-4). whereas the the estimated coefficients from the systems estimators (Tables IV and V) are adjusted by the sample size. failing to include these terms may lead to misspecified dynamics captured in an ad hoc manner by lagged variables in conventional Q models. . Formally. and Wu (1973). note that the standard errors of the estimated coefficients from the single equation 15 estimators (Tables II and III) are adjusted by the degrees of freedom. and the 3SLS estimates in Table IV. Table V contains estimates of equation systems for equipment and structures.22 rejects the restrictions defining the Conventional Q level. we examine the role of inventory capital. and equals 6. and can be interpreted as the Lagrange multiplier version of the HDW test.999). Durbin (1954). If misspecification is present in the system. model at the 1% Further support for the MC model is obtained by comparing the IV and 3SLS estimates with the test proposed by Hausman (1978). columns 4-6.

875) for columns 3-4 and 13.721 (P > . the substantial increase in the latter P value confirms the importance of the inventory variables.186) for columns 5-6.23 models in Table V rejects the hypothesis that inventories can be excluded. . While both tests are below conventional significance levels.261 (P > . Complementary evidence is provided by the HDW test statistics of 8.

16 and use the estimated parameters to calculate the increments to investment and the capital stocks.37. remain on the stable manifold).061. We assume that V(t) increases unexpectedly by $1. and are quite consistent with the value of $.32 from the equation 16 These simulation results are comparable to and consistent with the evidence from other econometric investment models discussed in Chirinko (1986). the depreciation rate was set to .04. we examine in this section the response of investment expenditures to changes in V(t) (hence (t)) in both the CV and MC models.19 and $. A comparison of our method to that used by Summers (1981.. SIMULATIONS To evaluate further the Multi-Capital Q model. and 0. . perhaps due to a lump sum tax rebate. structures. . increments to the accumulated sum of the three capital stocks range between $. The system of investment equations (17) was augmented by the capital accumulation equations (11) with geometric depreciation rates of . 17 Since the lagged dependent variables are not part of the formal Q model and lead to explosive behavior. Ten years after the $1 shock.e. and inventory.24 V.17 These calculations will be only approximate because we are not constraining the solution to be consistent with the eventual steady-state (i. When the three capital inputs are aggregated. 1% in the tenth year. and the response of investment is quite slow. These results do not vary systematically with the CV or MC specifications. Table 6) indicates that the understatement of the accumulated capital stock is small: the bias is approximately 0% during the first five years. and 13% in the fiftieth year. The simulation results are reported in the Tables at the bottom three rows for each equation. respectively. they have been excluded in the simulations.13.0 for equipment.

A result not apparent in the aggregate equation is that inventories are accumulated at a disproportionately fast rate in the conventional model. one finds that the modifications to the Q model undertaken in this paper do little to attenuate the unreasonably sluggish response of investment to variations in L (t).25 based on aggregate capital (1). but the simulated changes in inventories are between 51-56% (CV models) and 19-32% (MC models). . For the sample period. In sum. the inventory stock is 25% of the aggregate.

One possible direction would be to modify the technology in order to recognize a buffer stock role for inventory investment but retain a traditional . SUMMARY AND CONCLUSIONS The poor empirical performance of Q models has led us to reexamine the conventional framework.26 VI. but indicate that further work remains. and the Conventional model was rejected in favor of the MultiCapital specification. Econometric evidence was generated with equipment. However. lagged variables proved significant. as has been the case in previous work with Q models. framework. Furthermore. The results reported in this paper thus provide substantial support for the Multi-Capital model as a useful extension to the Q In particular. By recognizing the possibility that the value of the firm depends on two or more capital inputs whose adjustment cost technologies may differ. inventories were shown to play a key role in the modeling of fixed investment expenditures within the Q framework. we have derived an econometric specification that nests the Conventional model as a special case. the response of the capital stock to unexpected changes in the economic environment remained unreasonably slow. for a number of the variants of the Multi-Capital model. and inventories considered as capital inputs. serial correlation in the residuals was important. and a number of the regressors had incorrect signs. structures.

27 adjustment cost approach for equipment and structures. in the event that the data associated with these types of capital are plagued by substantial measurement error. the MC framework could be extended to other capital inputs such as research and development. their inclusion may compromise the other coefficient estimates (cf. A more satisfactory model of capital accumulation may thus have to be based on an intertemporal technology that recognizes explicitly delivery. expenditure. human capital. the dynamics of fixed capital accumulation may be too complex to be captured adequately by the adjustment cost technology.18 Alternatively. 1980. 158). However. p.. the availability of suitable data. Fisher. and gestation lags and the possibility of non-exponential capital decay. or advertising/goodwill. 18 Given .

Yale University (May 1975). Investment and the Value of Capital (New York: Garland Publishing. "A Note on Investment and Lagged Q. "On the Inappropriateness of Empirical Q Investment Equations. 301 (May 1983). Dissertation. Ontario: John Deutsch Institute of Economic Policy. 1986). King. and Prediction. 23-32." Massachusetts Institute of Technology (December 1983). Inflation.R— 1 REFERENCES Abel." Cornell Ufliversity Working Paper No.. "Four Essays on Monetary Policy. "Errors in Variables.) The Impact of Taxation on Business Investment (Kingston. Chirinko. Olivier.. John H. Fischer. . Clark. "Investment in the 1970's: Theory. "The Present Value of Profits and Cyclical Movements in Investment." Northwestern University (June 1982a)." in Jack Mintz and Douglas Purvis (eds. James. and ________ Ciccolo." okings Papers on Economic Activity (1979:1)." Review of the International Statistical 1nstitut 22 (1954). Robert S. 1979).. Stephen R." Harvard University (October 1984). Andrew B. "Hidden Stimuli to Capital Formation Debt and the Incomplete Adjustment of Financial Returns. 272-281. 73-124. Peter K. Durbin. Performance.. "The Not-So-Conventional Wisdom Concerning Taxes. and Capital Formation." National Tax Association . Stanley." Unpublished Ph.Tax Institute of America Proceedings _____ 1982b.. "Will 'The' Neoclassical Model of Investment Please Rise?: The General Structure of Investment Models and Their Implications for Tax Policy.D. and Blanchard.

" Northwestern University (April 1982b).R.. P.) Ouantitative Economics and Development: Essays in Memory of Ta-Chung Liu (New York: Academic Press. 213-224. and Sargent. Jerry A. . Interest Rates. Robert E.." Brookings Papers on Economic Activity 1977:1). The General Theory of Employment. "The Effect of Simple Specification Error on the Coefficients on 'Unaffected' Variables. reprinted in Studies in Business-Cycle Theory (Cambridge: MIT Press.J. Clive W. Granger. —." Journal of Economic Dynamics and Control 2 (February 1980)." Econometrica 50 (January 1982a). and Newbold. 1980). Jr. Andrew C. Lucas. 111-120. "Generalized Instrumental Variables Estimation of Nonlinear Rational Expectations Models. "Real Wages.. Harvey. and S.. Hansen." in L. "Econometric Policy Evaluation: A Critique. 1251-1271. Franklin M." American Economic Review 53 (May 1963). 1981).R— 2 Fisher.. Thomas J. 247-259. and Investment in the Theory of Adjustment Costs. Tsiang (eds. Klein.. Interest and Money (New York: Harcourt. Employment. Keynes. 9-46. Jorgenson. Fumio. Hayashi. "Capital Theory and Investment Behavior." Journal of Econometrics 2 (July 1974). Hall. Nerlove. "Formulating and Estimating Dynamic Linear Rational Expectations Models.. Dale W. Hausman.." Ecpnometricp 46 (November 1978). and Singleton. "Investment." Econometricp 50 (September 1982).. 1269-1286... "Tobin's Marginal q and Average q. 61-103. and the Effects of Stabilization Policies. 19-46.C. "Specification Tests in Econometrics. Brace. The Econometric Analysis of Time Series (New York: John Wiley. M. Kenneth J." IJi Phillips Curve and Labor Markets. 1981). Lars P. 157-163. 1964). Carnegie-Rochester Conferences in Public Policy 1 (1976). "Spurious Regressions in Econometrics. Robert E.. John Maynard.

James M. Lawrence H.. 153-178. 203-210. "The q Theory of Investment with Many Capital Goods. and Banking 1 (February 1969)." Journal of Money. "Taxation and Corporate Investment: A qTheory Approach. 67-127. 221-251. 739-743. Matthew D. D. "External and Internal Adjustment Costs and the Theory of Aggregate and Firm Investment. "The Dynamic Demand for Labor and Capital. "Lags in Economic Behavior." Journal of Public Economics 22 (March 1983)." Brookings Papers on Economic Activity (1981:1). \Vildasin. Summers.. Hiroshi. and Summers. Yoshikawa. "A General Equilibrium Approach to Monetary Theory. 135-167. Michael." American Economic Review 70 (September 1980). Macroeconomic Theory (New York: Academic Press.. "On the 'q' Theory of Investment. Sargent. Wu.. Poterba." Econometrica 41 (1973). "Dividend Taxes. David E. 1979).R—3 Mussa. Credit. and Q. 513-542." Econornica 44 (May 1977). Thomas J. "Alternative Tests of Independence Between Stochastic Regressors and Disturbances." Econometrica 40 (March 1972). 733750." Quarterly Journal of Economics 101 (August 1986)." American Economic Review 74 (March 1984). Corporate Investment. Marc. James. .. 1529. Lawrence H. Shapiro... Tobin. Nerlove.

1909-1975.. George M." Journal of ST - Seater." Federal Reserve Bank of New York Quarterly Review 4 (Autumn 1979)." on Economic Activity (1977:2). "Corporate Investment: Brookirigs Papers . The National Income and Product Accounts of the United States 1929-1976 Statistical Tables (September 1981). NIPA - U. and Sahling. Patrick J. "Business Tax Policy in the United States: 1955-1980. Unpublished data provided by the Bureau of BS CEA - U. (1940-1975). Board BAL - BEAU Economic Analysis.S. Department of Commerce. Business Statistics (1982. Security Price Index Record.S. of Economic Advisers. Department of Commerce. Bureau of Economic Analysis: (1976-1978).S.. 1945-82. For a related publication... Bureau of Economic Analysis. 8102 (September 1981). "Balance Sheets for the U. Leonard. see Corcoran. Council CS - Corcoran. Monetary Economics 10 (November 1982). 1984. 13-24.S. von Furstenberg. S&P - Standard & Poor's Statistical Service. John J." (October 1983). 1971). VF - Does Market Valuation Matter in the Aggregate?. 1984). "Marginal Federal Personal and Corporate Income Tax Rates in the U..S. Survey of Current Business 62 (July 1982). "Inflation.G— 1 GLOSSARY SOURCES: of Governors of the Federal Reserve System. 347-397. Taxes. and unpublished data provided by the authors. Research Paper No. Economic Report of the President (Washington: U. Economy." Federal Reserve Bank of New York. and the Composition of Business Investment. 361-381. Patrick J. Government Printing Office.

BOP: S&P. FLO for the previous period: NIPA.table. BOP: S&P. T1. FLO: BEAU. DEFIN ITIONS: A* - Present discounted value of tax depreciation allowances from assets purchased prior to period t. p.line.Leverage - ratio: B* / (B* + V). INT Current - . 118. - BOP: NIPA. dollar investment for nonfinancial corporate business (j = equipment. DSP i Standard & Poor's dividend-preferred stock price ratio. BOP: NIPA. inventories). - Moody's nominal interest rate on corporate Aaa bonds. and BS. p. S-16.13. L31. FLO - BOP - beginning column. T . BOP: Cs. b . Ii Constant dollar net interest paid by nonfinancial corporate business. structures.C— 2 LEGEND: Cflow over the period. of the period. Current DIV - DSPC - Standard & Poor's dividend-common stock price ratio. L35.middle of the period.13. BOP: (NETINT * (MIP / INT)) / i). L . dollar market value of debt issued by nonfinancial corporate business. 127. MOP . B* Current dollar dividends for nonfinancial corporate business. T1.

L15. structures. Constant K - for nonfinancial corporate business (j = inventories).kJ . BOP: NIPA. T2. L39. L9. where the latter variable equals - SP CEA. 54.13. TB-90. structures): (1 . BOP: BAL.t z).7. FLO for the previous period: NIPA. structures.1087. L17. Implicit price deflator for gross domestic purchases. BOP: NIPA.C— 3 kCS.3. dollar net monetary interest paid by nonfinancial corporate business. Tl. p. Standard & Poor's composite stock price index. T8. L7 less L25. inventories). p p - the (l-wdjv) mean of the percentage change in SP over the previous four periods. which implies that 90% of a debt issue would be retired after 20 years. L16. T7. Tax . Current Rate NFA of debt retirement: . MOP: t rj U - Rate of federal taxation of corporate income: ST. C6. L35. Current NETINT - dollar noninterest bearing net financial assets of nonfinancial corporate business. BOP: BEAU. less L37. Rate of investment credit (j = equipment. T705. L38. MIP Current K$ - Current dollar replacement value of the capital stock equipment. BOP: BAL T705. credits and deductions on capital services = equipment. L4. L18. structures): dollar replacement value of the capital stock for nonfinancial corporate business (j equipment. dollar net interest paid by nonfinancial corporate business. BOP: (wdjv DSPC + DSP) + LAG4(SP/SP). Firms' nominal rate of discount.

BOP: b{[((1-t)i + ri) / (p + 1)] . extended for the current study.G-4 index for investment expenditures on asset j: calculated implicitly with K$. Current - Difference between the value of the firm evaluated on + (1t)K1$ + NFA)] / (l.O}. fn. 11. for the purchase of investment goods provided by debt finance. structures): CS. BOP: DIV / (wdjv DSPC + (l-wd1) DSP). vV- Price dollar market value of equity for nonfinancial corporate business. Appendix E. BOP: [(V + B*) Wdjv - (tK$ + Percentage of dividends paid on common stock: VF. Subsidy - discounted value of current and future tax depreciation allowances per dollar of investment in period t Zj - Present (j = equipment. financial markets and the net-of-tax replacement value of its assets.1. 358. p.t) p. .

374 . respectively. .TABLE I SERIAL CORRELATION COEFFICIENTS EQUIPMENT.189 .263 2 3 . Critical values are .753 .728 1 .496 and . INVENTORIES* Lag Length Equipment Structures (2) Inventories (3) (1) .388 at the 1% and 5% levels.896 . STRUCTURES. * Sample period 1953-1978.658 All series scaled by their own capital stocks.425 -.200 -.

0913 — -.0593 .3425 56.0449 (.0082 .1419) .1818) -——— 2625a (.0051 (.0089 . the corresponding capital stock represents the constant term.0115 . All explanatory variables are scaled by the capital stock for the dependent variable.2659 (.1744) -.8944 (.0680) — .8572 (.0010) •0029a .20 123.7970 77.7275 -.7819 (. Sum.8259 1.8527 .4324 1.0329 .01 40 (. The dependent variable is indicated by the column heading.1832) — -——— Iin(tl) — — .0128) (.0105) (.0027) — •2706a — (.0266) st(t) — — .0978) .0304 (.0031 (.0868 (.1414 .1490 ——- (.0395 . . b Significant at the 5% level.2731 .71 . .0341 .1382) —— .0724 .0452) 0942a 2485a .1451) .0793 3.0018) 0025a (.0550 *Estimates based on equation (17).0545) 13900a (.0649 . Standard errors in parentheses.0347 .l) — ——•7398a (.1000) .0041 (.0327 .0020) -—— — (.0254 (.0795a (.5878 .9303 .0694 .18 Simulations (dKLi secondyear fifthyear tenth year .0556) (t-1) lst(t.1609) — —— 7820a (. a Significant at the 1% level.0137 .0634 .0197) K5t(t) l(t) Kin(t) —— — 0372a (.741 Criterion 82.7154 2.1941) . Residual Sum of Squares multiplied by i02. for a given equation.1558 — —— .0671) -.1526 101.155 111.0082 .0631) 5096a (.0008) .0312) .4812) .954 .TABLE II CONVENTIONAL AND MULTI-CAPITAL Q MODELS ORDINARY LEAST SQUARES ESTIMATES Corw1bn Variable or Sta1ist EQ (1) Multi-CtaI ST (2) IN (3) EQ (4) ST (5) IN (6) . thus.0012 (.1064) Keq(t) . Sample period 1950-1978.3114) — (.0035) -.1567a (.0144 .0311 .2230 m Res. Sq.0692 (.6410 — -.5282a (.0331 3.

All explanatory variables are scaled by the capital stock for the dependent variable.1118) (.7812) .7968 .0033) — ——— -.3978 .334 10.0281) 3226b 13813a (.0479 118.3128 1.1577) (.0242) (.0884 .0022 (. Criterion for IV divided by the variance of the regression error.0482 .1020) .1936 (.1406) —— ——- .4665a (.0796 .0752) l(t) — ——— .0407 .1188) (. Criterion 89.0247 (.1408 (. The dependent variable is indicated by the column heading.1491 (.0009) . a Significant at the 1% level. Residual Sum of Squares multiplied by i02.2574) (.1731 — -.5285) 17448a (.6759 .709 -.0335 .0297) .1975) .1573) lin(tl) -.9431 8. thus.1812) K(t) Iq(t1) Ist(tl) . Sq.2048) -.1005) — .7910 — -1 .1388) .1631 — — (.0104 .1128 -. Sample period 1950-1978.0864a (.01 19a EQ (4) ST (5) IN (6) (t) I(t) Keq(t) 0082a (.2261) (.3583 2.8199 Res. Sum.0403) -.0459 . for a given equation.0620 3532b ————————- (.4170 (.0381 .0718 (.472 (.0902) •2767a (.0026) 0029a (.0231 .0704 .3913 .1105 .0849 (.3308) 17194a (.3189 .1526) .2318 -.1315 .5911 m .334 8.0086 .TABLE III MULTI-CAPITAL Q MODELS REDUCED FORM AND INSTRUMENTAL VARIABLES ESTIMATES Reduced Form Instrumental Variables Variable or Staustc EQ (1) ST (2) (3) .1444) .0692) (.0225 (.0902 Estimates based on equation (17).1449) .4944 .0946) lst(t) ——— —— 2023a .0019 (.0604) (.0655 (.6126) 1832a (.0009) (. Standard errors in parentheses.8274 65.0021) 0037a (.0719) (.0047 (.lO4Ba (. .2230) 12828a (.0825 .4994) — (.1628 -. b Significant at the 5% level.0697) (.3753 ——— .0173 .51 -.0108 .0369 . the corresponding capital stock represents the constant term.2534 (.0716) 5863a •1083a K8t(t) oo (.0653) .5567 Simulations (dKi secondyear fifth year tenth year .0779 .0034) -.4894) 2g245a (.

1 140) ——- .0212 .0357 .1400) 1.0086 (. All explanatory variables are scaled by the capital stock for the dependent variable.{61.0385 0023b (.0659 .l624c •Estimates based on equation (17).0752) -.(t) K1(t) —— —— 0391a (.0019) I(t) Keq(t) —— — —— . C The insignificant coefficient set to zero.0168) (.0392 .0552) 1•2157a — 1g877a (.0423) •1427a •3787a (.Sq.0088 .0115 .2089 (. for a given equation.0568) 6224a (.1486 .0189 ——-—-—-——.0149 .0914 .TABLE IV CONVENTIONAL AND MULTI-CAPITAL 0 MODELS THREE STAGE LEAST SQUARES ESTIMATES Converitbnal MCtaJ IN (3) Variable or Statstc EQ (1) ST (2) EQ (4) ST (5) IN (6) (t) 0041b (.0533) .0065 .3300) — (.0087) (.0033) .8745 3. thus.0042b (.0483 .0789) ——-- (.0230) g8a (.007 (. The dependent variable is indicated by the column heading.0525 (21 . a Significant at the 1% level.0007 (.0007) — (.0859) (.0009) .3138a (.3511 .{ secondyear fifth year tenth year .0241 . b Significant at the 5% level.0491) m 2.0066 (.560} -.1064 — —-————- —- .0018) •0032a .0700) — -. Residual Sum of Squares multiplied by i02.1118) ——— I(t-1) — (.3819 Res.7795 . Standard errors in parentheses.0841 — — 8191a (.0618 .4645) 2343a (.0547) (.0g8ga (.1235) (.0846 3.Sum. Sample period 1950-1978.0680 .1961 -.1321) I(t-1) 151(tl) — —————— — •9223a — (. .0121 .0209) 1tt) K5t(t) —— —— .5888 .0053 (.6636 .0557 .1213) -——— 2155a (.l355c .364} ——-————----—- Simulations (dK.0856 .0105) I. the corresponding capital stock represents the constant term. Criterion 1.1060) •1405b 5220a .0026) 1 5876a (.

0057 .0009) (.1273) — (.0847 .4390 .0846) Keq(t) .2302 .0085 2544a (.0024a (.631) ——. Sq.0455) -. .0036) .0008) .0260) 1481b — 5087a •0g35a (.0498 -.0106) — .0474 — (.2022 -.0020) OO3 (.0857 (.0473a (.723) ——— ——— {35.0239 . Residual Sum of Squares multiplied by i02.0332 (.0138) l(t) 2g28a (.0278 -.0065 .1514) — •9236a (.0152 .1033) l(t1) m 1. thus.TABLE V CONVENTIONAL AND MULTI-CAPITAL 0 MODELS ThREE STAGE LEAST SQUARES ESTIMATES* Conventbnai Variable or Statisti EQ (1) - ________________________________________ EQ (3) ST Multi-Capital ST (2) EQ (5) ST (6) (4) •0041b 0023b (.1395 (.0480 .2830) (.0393 .1086) .0244 .0115 .4557 . b Significant at the 5% level.3713) -1.5910 2. The dependent variable is indicated by the column heading.0860) -. the corresponding capital stock represents the constant term.0922 .0019) leq(t) 0046b (.0618 .(20.105c — (.0600 Estimates based on equation (17).0518 .0303 .0760) K(t) I(t-1) Ist(t1) 8503a 2472a -.0557) (.0571) l5t(t) 1. a Significant at the 1% level.0083 .6971 1.1151) ——— — 5876a (.0774) (.3206a (.0123) (.0484 (.0690 .0421 Res.0007) — (.0055 -.0489 Criterion ——— (40. for a given equation.6505 .0530) 6231a .008 (.1724) 10654a (.1020) 0658a (. Sum.0239) — .1159 (. Sample period 1950-1978.0186) (.883} Simulations (dK1fdc1 second year fifth year tenth year . .7165) •1356a Kst(t) — (.7537 1. All explanatory variables are scaled by the capital stock for the dependent variable. Standard errors in parentheses.0856 .

- On Writing
- The Shell Collector
- I Am Having So Much Fun Here Without You
- The Rosie Project
- The Blazing World
- Hyperbole and a Half
- Quiet Dell
- After Visiting Friends
- Missing
- Birds in Fall
- The Great Bridge
- Who Owns the Future?
- The Wife
- On Looking
- Catch-22
- A Farewell to Arms
- Goat Song
- Birth of the Cool
- Girl Reading
- Galveston
- Telex from Cuba
- Rin Tin Tin
- The White Tiger
- The Serialist
- No One Belongs Here More Than You
- Love Today
- Sail of Stone
- All My Puny Sorrows
- Fourth of July Creek
- The Walls Around Us

Are you sure?

This action might not be possible to undo. Are you sure you want to continue?

We've moved you to where you read on your other device.

Get the full title to continue

Get the full title to continue reading from where you left off, or restart the preview.

scribd