Investment, Q und Liquidity, Evidence for Germany Using Firm Level Balance Sheet Data

We analyse the investment behavior of German firms within the framework of the Q-theory. Because we use anonymous individual firm balance sheet data, no stock market measure of Q is available. The data set contains 1,342 manufacturing firms covering the period 1987 to 1998. Using the approach of Abel&Blanchard and Gilchrist&Himmelberg, a measure of Q is derived through a vector-autoregressive-model to forecast future profits directly. The estimation results of dynamic investment equations reveal that Q influences the firm's fixed investment spending significantly. When supplementing the Q-investment equation, sales influences investment significantly whereas there is no cash flow influence. Using different indicators to characterize firm's financial situation, we find no evidence of financial constraints which result in a stronger cash flow influence. While this study supports the Q-theory of investment, no evidence is found to support the effectiveness of a balance sheet channel.