Theory posits that when managers anticipate excess capacity, average q becomes a biased estimator of marginal q as the potential for underutilizing new capital diminishes the marginal benefit of investing. After correcting for this source of measurement error, the explanatory power of Tobin’s q model substantially improves in time-series and cross-sectional regressions as well as in out-of-sample tests. These findings, combined with a secular erosion in capacity utilization, seem to explain why corporate investment rates have been declining for decades despite a significant increase in average q. Our analysis indicates that economic rigidities have contributed to the persistent erosion in capacity utilization.
Read the full version of David’s paper here.
