There are many papers which show that incorporating intangible assets help Tobin’s-Q (the ratio of price to replacement cost) to explain investment levels, both at the macro level and micro level. In theory, when prices are higher than replacement cost, firms should be investing to exploit the gap, the increased investment increases competition, which brings down returns on capital and help price to converge to replacement cost.
The neoclassical theory of investment has mainly been tested with physical investment, but we show it also helps explain intangible investment. At the firm level, Tobin’s q explains physical and intangible investment roughly equally well, and it explains total investment even better. Compared to physical capital, intangible capital adjusts more slowly to changes in investment opportunities. The classic q theory performs better in firms and years with more intangible capital: Total and even physical investment are better explained by Tobin’s q and are less sensitive to cash flow. At the macro level, Tobin’s q explains intangible investment many times better than physical investment. We propose a simple, new Tobin’s q proxy that accounts for intangible capital, and we show that it is a superior proxy for both physical and intangible investment opportunities.