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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.
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