Abstract
We investigate empirically how the distributional dynamics of firm investment rates and firm size affect aggregate US investment during the period 1962-2006. We find that the cross-sectional covariation between firms’ investment rates and their relative size accounts on average for about half of aggregate investment rate. The negative sign of this covariance implies that a mean-preserving increase in the cross-sectional dispersion of investment rates and/or relative size reduces aggregate investment rate. We investigate the implications of firm-level conditional convergence in corporate investment rates on the dynamics of aggregate investment. We identify the cross-sectional variance of firm relative size as being particularly relevant to explain aggregate investment dynamics. With aggregate NIPA investment data, the cross-sectional variance of firm size fits the investment equation better than the traditional measure of Tobin’s Q and it drives out cash flow.
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