Investment and Value: A Neoclassical Benchmark

Which investment model fits firm-level data? To answer this question we estimate alternative models using Compustat data. Surprisingly, the two best-performing specifications are based on Hayashi's (1982) model. This model's implication that Q is a sufficient statistic for determining a firm's investment decision has been often rejected because cash-flow and lagged-investment effects are present in investment regressions. But, we find that these regressions are quite fragile and ineffectual for evaluating model performance. So, forget what investment regressions told you. Models based on Hayashi (1982) provide a very good description of investment behavior at the firm level.