Tobin’s q and Investment in a Model with Multiple Steady States

This paper studies a simple dynamic investment decision problem of a firm where adjustment costs have capital size effects. This type of setting possibly results in multiple steady states thresholds and a discontinuous policy function. We study the global dynamic properties of the model by employing the Hamilton-Jacobi-Bellman method and dynamic programming that help us in the numerical detection of multiple equilibria and thresholds. We also explore the model’s implications concerning the effects of aggregate demand, interest rates and tax rates. Finally, an empirical study on the firm size distribution is provided using U.S. firm size data. We utilize two different approaches, Kernel density estimation and Markov chain transition matrix to study an ergodic distribution. Our results suggest twin-peak distribution of firm size in the long run which empirically supports the theoretical conjecture of the existence of multiple steady states. JEL Classification Numbers: E22