Fixed Costs: The Demise of Marginal q

Ricardo J. Caballero, John V. Leahy

NBER Working Paper No. 5508
Issued in March 1996
NBER Program(s):   EFG

The standard version of q theory, in which investment is positively related to marginal q, breaks down in the presence of fixed costs of adjustment. With fixed costs, investment is a non-monotonic function of q. Therefore its inverse, which is the traditional investment function, does not exist. Depending upon auxiliary assumptions, the correlation between investment and marginal q can be either positive or negative. Given certain homogeneity assumptions, a version of the theory based on average q still holds, although under the same assumptions profits and sales perform as well as average q. More generally, q is no longer a sufficient statistic.

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