Dynamic Investment and Product Market Rivalry: The Network Q Model

<jats:p>We present a new dynamic model of corporate investment in imperfectly competitive product markets that extends the neoclassical mathematical theory of capital to accommodate heterogeneous, multi-product firms and a rich hedonic demand system. Our model endogenizes firms' markups and generalizes Tobin's mathematical to a matrix (or network) of product market spillovers, which captures how each firm's investment affects that of its rivals. We provide equilibrium existence and uniqueness results along with global analytical solutions for the firms' investment policies. We then take our model to the data for the universe of US public companies and obtain four novel insights: 1) product market competition is a key driver of aggregate investment and capital allocation; 2) shocks to firms' cost of capital generate highly heterogeneous investment and markup responses across firms, and thus impact industry concentration; 3) monopoly rents account for a large, rising share of firms' value; 4) mergers consummated since 1995 have led to a modest decline in the aggregate capital formation of merging firms, yet firm-level markup increases have been highly heterogeneous.</jats:p>