Excess Capacity, Marginal q and Corporate Investment
55 Pages Posted: 22 Jul 2020 Last revised: 1 Sep 2021
Date Written: July 1, 2021
Theory predicts that when managers expect the firm to operate below full capacity, marginal q will be less than average q as the prospect of underutilizing new capital reduces the marginal benefit of investing. To control for this potential bias in average q, we augment the q model with a proxy for capacity utilization. This adjustment substantially improves the explanatory power of investment regressions relative to traditional models. Moreover, our findings indicate that investment is remarkably sensitive to capacity utilization. These results, combined with the erosion in capacity utilization over time, seem to explain the puzzling secular decline in the rate of corporate investment despite a material increase in average q. These empirical findings hold across all G7 countries and are robust across a variety of dimensions.
Keywords: Corporate Investment, Tobin’s q, Marginal q, Asset Utilization, Capacity Utilization, Excess Capacity
JEL Classification: D24, E22, G31
Suggested Citation: Suggested Citation