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

See all articles by Hang Bai

Hang Bai

University of Connecticut - Department of Finance

Erica X. N. Li

Cheung Kong Graduate School of Business

Chen Xue

University of Cincinnati

Lu Zhang

Ohio State University - Fisher College of Business; National Bureau of Economic Research (NBER)

Date Written: October 8, 2019

Abstract

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

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

Hang Bai

University of Connecticut - Department of Finance ( email )

School of Business
2100 Hillside Road
Storrs, CT 06269
United States

Erica X. N. Li

Cheung Kong Graduate School of Business ( email )

Oriental Plaza, Tower E3
One East Chang An Avenue
Beijing, 100738
China

Chen Xue

University of Cincinnati ( email )

College of Business Administration
Cincinnati, OH 45221
United States
(513) 556-7078 (Phone)

Lu Zhang (Contact Author)

Ohio State University - Fisher College of Business ( email )

2100 Neil Avenue
Columbus, OH 43210-1144
United States
585-267-6250 (Phone)

National Bureau of Economic Research (NBER)

1050 Massachusetts Avenue
Cambridge, MA 02138
United States

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