Does Costly Reversibility Matter for U.S. Public Firms?
Yes, most likely. The firm-level evidence on costly reversibility is even stronger than the prior evidence at the plant level. The firm-level investment rate distribution is highly skewed to the right, with a small fraction of negative investments, 5.79%, a tiny fraction of inactive investments, 1.46%, and a large fraction of positive investments, 92.75%. When estimated via simulated method of moments, the standard investment model explains the average value premium, while simultaneously matching the key properties of the investment rate distribution, including the cross-sectional volatility, skewness, and the fraction of negative investments. The combined effect of costly reversibility and operating leverage is the key driving force behind the model’s quantitative performance.
We thank Rene Stulz and Toni Whited for useful conversations on measuring firm-level investment rates and Karen Wruck for helpful comments. We also thank Berardino Palazzo for sharing the codes and data used to generate Figure 1 and Table 1 in Clementi and Palazzo (2019). All remaining errors are our own. The views expressed herein are those of the authors and do not necessarily reflect the views of the National Bureau of Economic Research.