Marginal q, Tobinʹs q, Cash Flow, and Investment

Many studies of the determinants of investment use Tobinʹs q to control for the investment opportunities of a firm. Tobinʹs q roughly measures the average return on a firmʹs capital anticipated by the market. More relevant for investment decisions, however, is the marginal return on capital. In this paper we estimate investment and research and development (R&D) equations using a measure of marginal q. We use marginal q to identify the existence of cash constraints and managerial discretion and as a separate explanatory variable. For a sample of 560 U.S. firms observed over the 1977-1996 period we present evidence confirming the existence of both cash constraints in some companies and managerial discretion in others.