Convergence in Corporate Investments

Abstract:     
We provide robust empirical evidence of conditional convergence in corporate investments. Small firms have significantly higher investment rates than large firms, even after controlling for standard empirical proxies of firm real investment opportunities and financial status, including Tobin's Q and cash flow. Firm size is at least as important as Tobin's Q and cash flow, both economically and statistically, in explaining variation in corporate investments. Unlike the cash flow effect, however, the convergence effect is robust to measurement error in Tobin's Q. The empirical evidence suggests that firm size improves the measurement of firms' unobservable real investment opportunities rather than reflecting differences in firms' financing frictions. Using simulated method of moments, we estimate a simple neoclassical model of investment and show that technological decreasing returns to scale, along with measurement error in Tobin's Q, replicates successfully the empirical evidence on conditional convergence.

Number of Pages in PDF File: 62

Keywords: Corporate Investment, Convergence

working papers series