Many studies use linear regressions of investment on Tobin’s Formula: see text to estimate normal investment levels, often concluding that financial reporting quality enhances investment efficiency. Our findings suggest these inferences are confounded by two key factors. First, consistent with asymmetric capital adjustment costs, investment is significantly less responsive to Formula: see text values below one than to those above one. Second, firms with Formula: see text values below one systematically exhibit lower financial reporting quality. By pooling Formula: see text values above and below one, the standard linear investment–Formula: see text model introduces substantial upward bias in prior estimates of the relation between reporting quality and investment efficiency. To address this issue, we propose a piecewise linear specification of the investment–Formula: see text model that accounts for the distinct characteristics of observations when Formula: see text is below one. This adjustment is crucial when the likelihood of Formula: see text falling below one is systematically linked to the hypothesized determinants of investment efficiency. This paper was accepted by Shiva Rajgopal, accounting. Funding: The authors gratefully acknowledge financial support from the Berkeley Haas Center for Financial Reporting and Management. Supplemental Material: The data files are available at https://doi.org/10.1287/mnsc.2024.08732 .
Dutta et al. (Thu,) studied this question.