Discussion Paper

No. 2007-38 | August 28, 2007
Modeling the Effects of Financial Constraints on Firm's Investment


The paper develops a model of firm´s investment under uncertainty with financial market imperfections and analyzes the effects of financial constraints on firm´s investment. Firm´s investment is an increasing function of the firm´s marginal q, however the investment function is characterized by an upper bound that depends on the firm´s borrowing capabilities. The firm´s marginal q is the sum of the expected value of the marginal profitability of the physical capital stock and of a positive external finance premium. In the presence of financial market imperfections the firm forms expectations about future financial conditions and these expectations raise the firm´s current marginal q. Similarly, the shadow price of firm´s debt is the sum of the interest cost of debt repayment and of a provision for external finance that depends on the firm´s expectations over future financial conditions.

JEL Classification:

D92, E22


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Cite As

Gian Maria Tomat (2007). Modeling the Effects of Financial Constraints on Firm's Investment. Economics Discussion Papers, No 2007-38, Kiel Institute for the World Economy. http://www.economics-ejournal.org/economics/discussionpapers/2007-38

Comments and Questions

Anonymous - Referee Report
September 10, 2007 - 10:02

see attached file

Gian Maria Tomat - Acknowledgement of referee report
September 10, 2007 - 12:29

Main indications of the report are regarding the theoretical foundations of the model and its contribution. Some references to recent work are made for comparison.
I am willing to provide a revised version taking into account of the indications in the report.
In particular, since model is based on traditional ...[more]

... theory of investment I would tend to provide more foundations along the traditional investment literature, the literature on asymmetric information, agency and investment and the financial accelerator literature.
In turn a more clear description of the paper contribution would be provided. The field is the empirical estimation of investment equations, the paper provides a description of how measurement error can bias estimates in models with q and financing contraints. I realize this is not stated clearly in the present version and that the exposition can be improved.
References to more recent literature could be made in the new version, although I usually tend to prefer foundations to articles that address similar issues from different point of departures. I could however have a closer look at the suggested readings before turning a new version of the paper.
Finally a response to the other more specific points made could be made in due course.

Gian Maria Tomat - Reply to Referee Report 1
February 20, 2008 - 10:02

see attached file

Raoul Minetti - Referee Report
October 11, 2007 - 09:44

see attached file

Gian Maria Tomat - Reply to Referee Report 2
February 20, 2008 - 10:04

see attached file

Thomas D Jeitschko - Associate Editor´s Decision
October 11, 2007 - 09:52

In light of the two reports, I’m delighted to invite the author to revise his paper taking into consideration the comments received. I’m looking forward to reading the new version.

Anonymous - Comment on Discussion Paper 2007-38
October 16, 2007 - 15:46

Attached is an invited reader comment on "Modeling the Effects of Financial Constraints on Firm's Investment" by Gian Maria Tomat

Gian Maria Tomat - Reply to Invited Reader Comment
February 20, 2008 - 10:07

see attached file