Investment and Asset Prices with Financing Constraints

This paper investigates the role of financial market frictions on investment and the price of financial asset. We show that standard models with financial market imperfections can be summarized with a simple financing cost function, equal to the product of the financing premium and the amount of external finance. This parsimonious representation allows us to investigate the effects of financing constraints on firm level investment behavior. Specifically we derive explicit relations between investment and Tobin’s q in the presence of financial market imperfections. We show that this relation depends not only on fundamentals, such as profits and investment, but also on financing variables, such as financing premium and the amount of external financing. In addition we also derive a set of asset pricing restrictions that can be used to estimate the role of financial constraints on investment