Credit spreads and investment opportunities
Published online: 9 December 2015
Ó Springer Science+Business Media New York 2015
Abstract Do credit spreads signal ﬁrm investment opportunities just like Tobin’s q?
Because both credit spreads and Tobin’s q are market prices, they should contain similar
information about the ﬁrm. I develop an investment model in which an analytical relation
is established between the marginal q and the credit spreads. Using U.S. ﬁrm-level data, I
ﬁnd that credit spreads are a statistically important predictor of ﬁrm investment and their
explanatory power is higher than that of Tobin’s q. The empirical evidence shows that
credit spreads capture the effects of ﬁnancial frictions, which drive a wedge between
marginal and Tobin’s q.
Keywords Tobin’s q Investment Credit spreads Financial frictions
JEL Classiﬁcation G12 G30 E22
Determining how ﬁrms make investment decisions lies at the heart of corporate ﬁnance.
The leading theory is the q-theory of investment, which says that subject to capital
adjustment costs, investment decisions are driven by investment opportunities (marginal
q). Although its intuition is simple and appealing, attempts to test q-theory have met with
mixed success. The explanatory power of Tobin’s q in an investment regression is low.
One obvious problem when testing the theory is that the theory relates the optimal
& Tao Shen
Weilun 317, School of Economics and Management, Tsinghua University, Beijing 100084, China
Perhaps the most prominent example of the empirical failure of q-theory is the investment cash-ﬂow
sensitivity. Since the seminal work of Fazzari et al. (1988) and summarized by Hubbard (1998), a lot of
empirical papers show that investment responds strongly to movements in internal funds (proxied by cash
ﬂow) even after one controls for Tobin’s q. However, the recent literature (e.g., Kaplan and Zingales 1997;
Rev Quant Finan Acc (2017) 48:117–152