Aggregate Investment, Tobin's q and Insolvency Risk*

Paper number: 99/11

Paper date: September 1998

Year: 1999

Paper Category: Discussion Paper


Campbell Leith
University of Exeter


Despite being theoretically appealing, the standard q-theory of investment performs very poorly in empirical work. This paper extends the q-theory to include the possibility that costs associated with the risk of insolvency affect the firm's investment decisions. Using aggregate data for the UK business sector, the model is estimated both as a structural equation and in a less restrictive dynamic form which also allows for mis-measurement of Tobin's q by average q. The paper finds clear evidence that aggregate investment is influenced by the risk of insolvency.

JEL Classification Nos: E22, D92
Keywords: Aggregate investment, Tobin's q, financial constraints, insolvency risk

Corresponding Author: Campbell B. Leith, Department of Economics, University of Glasgow, Adam Smith Building, Glasgow G12 8RT, UK, tel: (44) 141 330 4618, fax (44) 141 330 4940, email:


* I would like to thank John Ireland for providing data and Andy Blake, George Bulkley, Elias Tzavalis, Simon Wren-Lewis and participants at the 1998 MMB conference at Warwick University, for helpful comments on an earlier draft of the paper. Financial support from ESRC grant no L116251026 is gratefully acknowledged.