Source: www.thomaspalley.com
Topic: Stock Investment
Sort Desciption: Keywords: q theory, stock markets, investment, arbitrage, cost of equity capital, .... investment raises questions regarding the shareholder - stock market ...
Content Inside: The Stock Market and Investment: Another look at the micro-foundations of q Theory Abstract This paper introduces a novel distinction between real q and financial q. The paper examines three versions of financial q developed by Brainard and Tobin, Minsky, and Hayashi. These theories differ regarding the nature of stock market price determination and their use of marginal productivity theory. It is shown that non-profit maximizing behavior by managers does not invalidate q theory. It is also shown that if managers and shareholders have different profit expectations, this leads to an equilibrium value of q that differs from unity. Lastly, the implicit claims in q theory regarding the efficient role of stock markets as regulators of capital accumulation are shown to depend on assumptions about stockholder behavior. JEL ref.: E2 Keywords: q theory, stock markets, investment, arbitrage, cost of equity capital, profit maximization. Revised August 1999 Forthcoming Cambridge Journal of Economics. Thomas I. Palley Assistant Director of Public Policy, AFL-CIO 815 Sixteenth Street, NW Washington DC 20006 1 I The implications of stock market q for policy The monetary transmission mechanism remains an enduring area of interest in monetary macroeconomics. Macroeconomic models have traditionally emphasized the interest rate channel which affects investment spending by establishing a hurdle rate of return for the marginal efficiency of investment. However, this traditional channel has been replaced increasingly by Brainard and Tobins (1968, 1977) q theory of investment. Their approach emphasizes equity prices, and shifts attention away from the bond and money markets toward equity markets. In place of interest rates, equity prices become the main channel whereby monetary policy affects investment spending (Blanchard, 1981). 1 The q approach to the transmission mechanism increases the macroeconomic significance of stock markets which now take on an important role i ...
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