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CESIS - Centre of Excellence for Science and Innovation Studies, Royal Institute of Technology KTH/CESIS Working Paper Series in Economics and Institutions of Innovation

No 157:
Q-theory of Investment and Earnings Retentions - Evidence from Scandinavia

Johan Eklund ()

Abstract: In a frictionless milieu retentions should have no impact on investment behavior. However, empirical studies typically find that retentions are an important determinant of investment. Managerial discretion and financial constraints are two alternative explanations that have been suggested. This paper uses a panel of listed Scandinavian firms to examine the importance of retentions as a determinant of investment. Measures of Tobinís Q, marginal q and sales accelerator are used to control for investment opportunities. Scandinavian firms are found to depend on retentions to a high degree, more so than in other developed economies. This high dependence on retentions suggests that the Scandinavian capital markets are suffering from allocational inefficiencies. Moreover, these market frictions appear too large to per se be caused by information asymmetries or managerial discretion phenomena. Possible institutional explanations are suggested.

Keywords: investment; liquidity; retained earnings; free cash flow; Tobinís Q; marginal q; (follow links to similar papers)

JEL-Codes: G30; (follow links to similar papers)

39 pages, December 3, 2008

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