Business Optimism for Small, Medium and Large Firms: Does It Explain Investment?*

Abstract

We use UK survey data on variation in business optimism by manufacturing size group to estimate the determinants of optimism using OLS and SURE. There are similarities across the size groups but also some differences: the medium‐size group seems to have been unusually affected by real interest rates in recent years. We also model investment authorisations, conditional on business optimism. Again, there are similarities across the size groups. However, the largest‐size group, and possibly also the medium‐size group, seem to be investing less in recent years in relation to reported optimism. By contrast, capital investment by smaller‐sized firms has been stable in relation to business optimism. Some tentative explanations for these findings are explored.

Financial constraints on investment: Effects of firm size and the financial crisis

“…A later paper published by the Institute for Fiscal Studies reported estimation of the optimism variable disaggregated by size with OLS and SURE. This confirmed that past and future demand indicators were the main drivers for all size groups with weak significance for the real interest rate (Driver 2007). In the light of this evidence we instrumented optimism by the first lag of the survey-based indicator of reported past output growth (OUTPASTt-1) and the contemporaneous indicator of output growth expectations (OUTNEXTt).…”

“…We use the transformed variables described above to estimate investment authorisation equations with business optimism as the main conditioning variable. This may be regarded as a type of accelerator equation with the forcing variable a composite indicator of factors such as sales and financing costs which are well captured by the optimism variable, as shown in Driver (2007). This specification for an investment equation follows the arguments in Chirinko (1993) that direct forward looking expectations are a good alternative to implicit models such as those based on the Euler equation or Q models using stock market data.…”