We study the impact of stochastic interest rates and capital illiquidity on investment and firm value by incorporating a widely used arbitrage-free term structure model of interest rates into a standard q theoretic framework. Our generalized q model informs us to use corporate credit-risk information to predict investments when empirical measurement issues of Tobin's average q are significant (e.g., equity is much more likely to be mis-priced than debt), as in Philippon (2009). We find, consistent with our theory, that credit spreads and bond q have significant predictive powers on micro-level and aggregate investments corroborating the recent empirical work of Gilchrist and Zakrajšek (2012). We also show that the quantitative effects of the stochastic interest rates and capital illiquidity on investment, Tobin's average q, the duration and user cost of capital, and the value of growth opportunities are substantial. These findings are particularly important in today's low interest rate environment.
Bibliographical noteFunding Information:
We thank Patrick Bolton, Simon Gilchrist, Steve Grenadier, Lars Hansen, Bob Hodrick, Thomas Philippon, Tom Sargent, Lukas Schmid, Bill Schwert (Editor), Suresh Sundaresan, and seminar participants at Columbia, and the discussants of workshops hosted by the China Young Finance Scholars Society for helpful comments. We are very grateful to the anonymous referee for invaluable comments which significantly improved our paper. The work was completed while Xiaoji Lin was at the Ohio State University. Jinqiang Yang acknowledges the support from the National Natural Science Foundation of China (#71522008, #71472117, #71772112, #71573033, #71532009, and #71532012), Innovative Research Team of Shanghai University of Finance and Economics (#2016110241), and Fok Ying-Tong Education Foundation of China (#151086).
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- Assets in place
- Bond q
- Capital adjustment costs
- Growth opportunities
- Term structure of interest rates