Does Costly Reversibility Matter for U.S. Public Firms?

NBER Working Paper No. 26372

Issued in October 2019

NBER Program(s):Asset Pricing, Corporate Finance, Economic Fluctuations and Growth, International Finance and Macroeconomics, Monetary Economics



Yes, most likely. The firm-level evidence on costly reversibility is even stronger than the prior evidence at the plant level. The firm-level investment rate distribution is highly skewed to the right, with a small fraction of negative investments, 5.79%, a tiny fraction of inactive investments, 1.46%, and a large fraction of positive investments, 92.75%. When estimated via simulated method of moments, the standard investment model explains the average value premium, while simultaneously matching the key properties of the investment rate distribution, including the cross-sectional volatility, skewness, and the fraction of negative investments. The combined effect of costly reversibility and operating leverage is the key driving force behind the model’s quantitative performance.

A section of this paper is devoted to a replication of, and comment on, NBER working paper 21064. The authors of that paper have posted a reply which may be found here.

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Acknowledgments

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Document Object Identifier (DOI): 10.3386/w26372