Tobin’s $q$ and corporate investment with a pandemic shock

Highlights

• We incorporate the COVID-19 shock into the investment adjustment costs framework.

• The adjustment cost amplifies the shock of the COVID-19.

• The optimistic vaccine expectations results in a more aggressive investment strategy.

• The epidemic shock uncertainty leads to higher corporate investment.

Abstract

We analyze the impact of COVID-19 on investment by incorporating a stochastic transmission shock into the standard $q$ theoretical framework. Our model suggests that the adjustment cost amplifies the negative pandemic shock to investment and decreases firm value. In particular, when the infection rate is low, the reduction in investment is higher for firms with low adjustment costs in that they are more sensitive to the infection rate. An optimistic expectation of the arrival rate of a vaccine reduces the probability of executing mitigation policy. Moreover, the uncertainty of the pandemic increases investment and enhances firm value during the pandemic regime.