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

Abstract

The empirical literature of investment under uncertainty has vastly neglected to account for the role played by market structure. Recently the theory has however started to merge real options theory with game theory to offer alternative explanations to strategic investment behaviour. This paper estimates an error correction model of investment under product price uncertainty for 23 French industries during the period 1977-1997 and represents the first empirical work that includes variables of market structure (in terms of degree of competition) in a model of investment under uncertainty. It is also one of the very first attempts to make explicit the empirical relationship between investment and uncertainty under different degrees of irreversibility. Although I find evidence that in general uncertainty has a negative impact on investment, the results show that the more concentrated industries are not significantly affected. Irreversibility, as predicted by theory, has a significant negative impact on investment, but when degree of competition and irreversibility are considered together it appears that the more concentrated industries can shield from the negative impact of uncertainty notwithstanding the presence of downward adjustment costs of capital. This seems in line with some of the recent developments proposed by the theory.JEL classification: C33, D80, E22, L16, L60

Piyasa Yapısının Belirsizlik-Yatırım İlişkisi Üzerindeki Etkileri: Türk İmalatSanayiinden Bulgular

“…By using industry level data from a panel of French two digit manufacturing industries and Herfindhal index as a proxy for competition, Maioli (2005) obtained similar results to Ghosal and Loungani (1996). She found that uncertainty has a negative and highly significant effect on investment.…”

“…According to the Model 2, DUMCR4 is statistically significant and has a negative effect on investment. The reductive effect of uncertainty on investment increases 6 Maioli (2005) also defined an industry as concentrated if the average value of the HHI was lying at or above the 75th percentile or the top 25th percentile (Maioli, 2005: 27 , "The Effects of Market Structure on Uncertainty-Investment Relationship: Evidence from Turkish Manufacturing Industry", Sosyoekonomi, Vol. 26(37), 185-200.…”

“…Consistent with the empirical literature on investment our dependent variable, investment, is defined as the ratio of investment to capital stock Ghosal and Loungani, 1996, 2000and Maioli, 2005. Investment and capital stock data are obtained from Annual Manufacturing Industry Statistics, provided by TurkStat (2010) and Taymaz et al (2008) respectively and deflated by using sectoral price indices.…”

“…Uncertainty variable, UNCERit denotes price uncertainty is calculated by using the standard deviation model based on equation (2). That method assumes that firms use the information on previous year's prices to forecast the current year price (Ghosal and Loungani, 1996;Maioli, 2005). Within this context, it is assumed that firms forecast prices based on the second order autoregressive model in equation (2).…”

“…Among these studies Bulan (2005), Henley et al (2003), Böhm et al (2000) and Guiso and Parigi (1999) support the results of Caballero (1991); uncertainty decreases investments under imperfect market conditions. On the other hand, Ghosal and Loungani (1996) and Maioli (2005) show that under imperfect competition the impact of uncertainty on investment is indeterminate.…”