QE and Yield-Oriented Investors : Depressing Implications for Investment

If the firm chooses the stock of capital, labor, cash (distributions) so as to maximize its expected discounted present value, its investment policy should adjust endogenously to changes in investor preferences. It is hypothesized that quantitative easing (QE) affects asset prices through a “portfolio balance channel” that does not exist in representative agent asset pricing models. It is possible that this channel arises because of the existence of “yield-oriented” investors who seek to maximize current income as well as holding period returns. I demonstrate that changes in the net demand of such investors may create strong incentives for firms to distribute rather than reinvest earnings to capitalize on the higher valuations ascribed to current cash flows. This endogenous adjustment in investment policy could help to explain why business investment has remained so weak despite the large increase in business cash flows, the sharp drop in financing costs, and and the increase in aggregate average Q since 2010