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

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

Bai, Hang and Li, Erica X. N. and Xue, Chen and Zhang, Lu, Does Costly Reversibility Matter for U.S. Public Firms? (October 8, 2019). Fisher College of Business Working Paper No. 2019-03-025, Charles A. Dice Working Paper No. 2019-25, Available at SSRN: https://ssrn.com/abstract=3466238 or http://dx.doi.org/10.2139/ssrn.3466238