NONLINEAR RESPONSE OF FIRM INVESTMENT TO Q - TESTING A MODEL OF CONVEX AND NONCONVEX ADJUSTMENT COSTS

Abel and Eberly (1994) study optimal investment behavior in the presen ce of flow fixed costs, proportional costs and convex costs. A clear p rediction is that investment will alternate between regimes of insensi tivity and responsiveness to q separated by unknown threshold levels o f q. At the firm level, we find evidence for different regimes of sens itivity to q but not for a regime of zero sensitivity. Our finding tha t 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. A ll rights reserved.