Investment and Value: A Neoclassical Benchmark
Which investment model best fits firm-level data? To answer this question we estimate alternative models using Compustat data. Surprisingly, the two best-performing specifications are based on Hayashi's (1982) model. This model's foremost implication, that Q is a sufficient statistic for determining a firm's investment decision, has been often rejected because cash-flow and lagged-investment effects are present in investment regressions. However, we find that these regression results are quite fragile and ineffectual for evaluating model performance. So, forget what investment regressions tell you. Models based on Hayashi (1982) provide a very good description of investment behavior at the firm level.
We thank Nick Bloom for helpful discussions on the estimation algorithm, Damba Lkhagvasuren for providing us with one of the algorithms used in the paper, and Caroline Sasseville and Niels Schuehle for research assistance. We also thank Bob King and Martin Eichenbaum for their comments. The views expressed herein are those of the author(s) and do not necessarily reflect the views of the National Bureau of Economic Research.