Excess Capacity, Marginalq, and Corporate Investment

Abstract

Theory posits that when managers anticipate excess capacity, averageqbecomes a biased estimator of marginalqas the potential for underutilizing new capital reduces the marginal benefit of investing. After correcting for this source of measurement error, the explanatory power of Tobin'sqsubstantially improves in time-series and cross-sectional regressions as well as in out-of-sample tests. These findings, together with a secular erosion in capacity utilization, help explain why corporate investment rates have been declining for decades despite averageqincreasing significantly. Our analysis indicates that economic rigidities have contributed to the persistent erosion in capacity utilization.