What Explains the Lagged Investment Effect?

The best predictor of current investment at the firm level is lagged investment. This lagged-investment effect is empirically more important than the cash-flow and Q effects combined. We show that the specification of investment adjustment costs proposed by Christiano, Eichenbaum and Evans (2005) predicts the presence of a lagged-investment effect and that a generalized version of their model is consistent with the behavior of firm-level data from Compustat.