Accounting for Asymmetry in the Investment– <i>q</i> Relation: Redux of Financial Reporting Quality and Investment Efficiency

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 .