Investment and q with Fixed Costs: An Empirical Analysis

Optimal investment depends both on expected returns and the costs of acquiring and installing capital. Empirical work using q-theory has emphasized the measurement of expected returns using Tobin's q, while more recent theoretical work focuses on investment costs, particularly fixed costs and irreversibility. This paper uses panel data to estimate a model of optimal investment and disinvestment using q to measure expected returns and allowing for a general "augmented adjustment cost function" -- incorporating fixed, linear, and convex adjustment costs. The results indicate both statistically and economically important nonlinearities, potentially arising from fixed costs, in the relationship between investment/disinvestment and its determinants. Our model suggests that investment and disinvestments should not be netted out empirically, and we find that disinvestment is non-negligible and behaves differently than positive investments. The nonlinearities we find imply that the cross-sectional distribution of q affects aggregate investment, so that the nonlinear model predicts annual aggregate investment substantially more successfully than does the linear model, particularly during large cyclical fluctuations.