THE EFFECTS OF INFLATION AND TAXATION ON THE VALUE OF CAPITAL
Abstract
Contemporary investment literature attempts to explain investment behavior through the use of two basic tools: the user cost of capital and Tobin's Q. The user cost relies on the rational postulate that a profit-maximizing producer utilizes sufficient capital such that its value marginal product equals its marginal cost. By measuring the user cost, a vernacularism for the marginal cost of renting a unit of capital, one is able to infer changes in the optimal input level of capital, and hence trends in investment. Alternatively, Tobin's Q is defined as the ratio of the market value of capital to its replacement cost. At the margin Q is unity. As Q exceeds unity there exists an incentive to acquire capital, since the increase in the market value is greater than the associated cost. Although obviously related, the connection between these two variables has not been formalized. This study finds that previous attempts in measuring Tobin's Q have been flawed through their inability to correctly measure the replacement cost of capital. Herein, a neoclassical model is developed that links the replacement cost to the discounted stream of expected user costs, as revealed through market rates and structural parameters. In other words, this study explains the macroeconomic market value of the firm by joining the microeconomic incentives of the shareholder-investor (through Tobin's Q) with the microeconomic incentives of the firm (through the value marginal product and user cost). I calculate the replacement cost of both plant and equipment for ten industries at the two-digit SIC industry level during the 1958-76 sample period. These are then used to econometrically estimate Tobin's Q. Finally, the replacement values of plant and equipment are used in explaining the gross investment series.
Degree
Ph.D.
Subject Area
Finance
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