Does Costly Reversibility Matter for U.S. Public Firms?
Fisher College of Business Working Paper No. 2019-03-025
Charles A. Dice Working Paper No. 2019-25
50 Pages Posted: 9 Oct 2019
Date Written: October 8, 2019
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.
Keywords: costly reversibility, the value premium, the standard investment model, simulated method of moments, operating leverage
JEL Classification: E22, E44, G12, G14
Suggested Citation: Suggested Citation