EXHUMING Q: MARKET POWER VERSUS CAPITAL MARKET IMPERFECTIONS

João Ejarque () and Russell Cooper

No 316, Computing in Economics and Finance 2000 from Society for Computational Economics

Abstract: Evidence of the statistical significance of profits in Q regressions remains one of the principal findings in the empirical investment literature. This result is taken to support the view that capital market imperfections are an important element for understanding investment. This paper challenges that conclusion. We argue that allowing the profit function at the firm level to be strictly concave, reflecting, for example, market power, is suscent to replicate the Q theory based regression results in which profits are a significant factor influencing investment. To be clear, our ability to replicate the existing results does not require the specification of any capital market imperfections. Thus the friction that explains the statistical significance of profits could be market power by sellers rather than capital market imperfections.

Date: 2000-07-05
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