Nonlinear response of firm investment to Q: Testing a model of convex and non-convex adjustment costs

Abel and Eberly (1994) study optimal investment behavior in the presence of flow fixed costs, proportional costs and convex costs. A clear prediction is that investment will alternate between regimes of insensitivity and responsiveness to q separated by unknown threshold levels of q. At the firm level, we find evidence for different regimes of sensitivity to q but not for a regime of zero sensitivity. Our finding that investment has a nonlinear relationship to q is important because it implies an elasticity of aggregate investment to q (and fundamentals) that is high and variable over time, (C) 1998 Elsevier Science B.V. All rights reserved.