Product Market Competition and the Impact of Price Uncertainty on Investment: Some Evidence From us Manufacturing Industries

Abstract

We estimate the impact of price uncertainty on investment using a panel of U.S. manufacturing industries. When we pool the data for all industries, uncertainty has no impact on current investment. However, this pooled estiimate conceals an interesting difference across industries. For industries with a high degree of product market competition, the estimated impact is negative, reasonably large, and significantly different from zero. For relatively non-competitive industries, the impact is always small and not significantly different from zero. The finding of a negative relationship between investment and price uncertainty in competitive industries is broadly consistent with the predictions of models that incorporate irreversibility of capital investment.

The Impact of Market Structure and Irreversibility on Investment under Uncertainty: An Empirical Analysis

“…I will use the degree of competition of an industry, as captured by the observable Herfindahl index, to accomplish this task. The results found are in contrast with what predicted by the traditional theory of the 90s [for example by Caballero (1991)], but is however in line with at least one other empirical study [Ghosal and Loungani (1996)], and I claim that this evidence is probably supporting the arguments of the very recent theoretical developments on strategic investment decisions.…”

“…It appears that imperfect competition plays a major role in determining the sign of the uncertainty-investment relationship. In fact, some empirical evidence showing that this is the case is available in Ghosal and Loungani (1996), Guiso andParigi (1999), Böhm, et al (2000), and Henley et al (2003). However, these studies reached opposite conclusions about the direction in which market power affects the uncertainty-investment relationship (but they also modelled different types of uncertainty).…”

“…However, these studies reached opposite conclusions about the direction in which market power affects the uncertainty-investment relationship (but they also modelled different types of uncertainty). Ghosal and Loungani (1996) use the four-firm seller concentration ratio (CR4) to measure the extent of product market competition in all US industries. They partition accordingly all the industries in sub-samples based on different industry concentration cut-off values of CR4.…”

On the sensitivity of firms' investment to cash flow and uncertainty

“…6 Brainard, Shoven and Weiss (1980) find that a CAPMbased risk measure yields mixed results on the linkages between investment and their uncertainty measure. Ghosal and Loungani (1996) report a negative role of output uncertainty on investment. Leahy and Whited (1996), using risk measures constructed from stock return data, argue that uncertainty exerts a strong negative effect on investment and point out that uncertainty affects investment directly rather than through covariances.…”

Investment, Idiosyncratic Risk, and Ownership

“…The intuition is that if a firm has a lot of market power, then it is more likely to exert downward pressure on the price by investing and increasing output. 14 Ghosal and Loungani (1996) find XXXX. In addition, a number of theoretical papers examine the effect of product market competition on managerial incentives [Hart, 1983;Scharfstein, 1988;Schmidt, 1997;Raith, 2003].…”