Excess Capacity, Marginal q, and Corporate Investment

Abstract

Theory posits that when managers anticipate excess capacity, average q becomes a biased estimator of marginal q as the potential for underutilizing new capital diminishes the marginal benefit of investing. After correcting for this source of measurement error, the explanatory power of Tobin's q model substantially improves in time-series and cross-sectional regressions as well as in out-of-sample tests. These findings, combined with a secular erosion in capacity utilization, seem to explain why corporate investment rates have been declining for decades despite a significant increase in average q. Our analysis indicates that economic rigidities have contributed to the persistent erosion in capacity utilization.

Keywords: Corporate Investment, Tobin's q-ratio, Marginal q, Asset Utilization, Capacity Utilization, Excess Capacity, Intangible Capital, Economic Rigidities

JEL Classification: D24, E22, G31