Abstract:
We study the response of investment to changes in uncertainty about future profits. We find that in
industries dominated by small firms, an increase in uncertainty about future profits depresses
investment; in all other industries, increased uncertainty has virtually no effect (or has a positive
effect) on investment. The data set from which these findings emerge is a balanced panel, consisting
of annual data from 1958 to 1991 for 252 manufacturing industries in the United States. The
theoretical work on this topic points to uncertainty about future profit flows as one of the important
actors that determines the ease with which firms can access external credit. The prediction made by
the theory is that an increase in uncertainty exacerbates informational asymmetries and hence makes
lenders reduce the flow of credit; this in turn lowers investment in credit-constrained firms. If one is
willing to accept firm size as a proxy for access to external credit, then our finding that greater
uncertainty lowers investment in small-firm-dominated industries is consistent with the theoretical
prediction.
|
