Fixed investment decisions in UK manufacturing: the importance of Tobin's Q, output and debt

In a neoclassical intertemporal framework real investment is determined by Tobin's marginal-Q. We develop this approach to include both agency costs of debt and regime changes, where in some periods the firm may be demand constrained. This leads to a 'wedge' between marginal and average-Q and in addition to the latter variable, investment depends on capital gearing and output. The model is used to explain UK fixed investment in the manufacturing sector 1968-1990 using an error-correction model and cointegration techniques. The statistical performance of the model, including parameter stability is satisfactory. Keywords: Investment; Tobin's Q; Output; Debt; Cointegration; Error-correction-model