Uncertainty, Capital Investment, and Risk Management

We use forward-looking and exogenous measures of output price uncertainty to examine the effect of price uncertainty on firm-level capital investment, risk management, and debt issuance. The effects of uncertainty vary significantly by firm size. When faced with high price uncertainty, large firms i...

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Bibliographic Details
Published in:Management science Vol. 64; no. 12; pp. 5769 - 5786
Main Authors: Doshi, Hitesh, Kumar, Praveen, Yerramilli, Vijay
Format: Journal Article
Language:English
Published: Linthicum INFORMS 01.12.2018
Institute for Operations Research and the Management Sciences
Subjects:
Capital
Capital expenditures
capital investment
Capital investments
Companies
Constraints
Debt
financial frictions
Hedges
Hedging
Hedging (Finance)
Influence
Investments
Management
Methods
Prices
Prices and rates
real options
Risk management
Securities
Small business
Uncertainty
ISSN:0025-1909, 1526-5501
Online Access:Get full text
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Summary:We use forward-looking and exogenous measures of output price uncertainty to examine the effect of price uncertainty on firm-level capital investment, risk management, and debt issuance. The effects of uncertainty vary significantly by firm size. When faced with high price uncertainty, large firms increase their hedging intensity but do not lower capital investment or debt issuance. In contrast, small firms do not adjust their hedging intensity but significantly lower capital expenditure and debt issuance even after controlling for investment demand. Moreover, the negative effect of uncertainty on capital investment is significantly weaker for firms that hedge their output price risk. Our analysis highlights that, in the presence of financial frictions, high price uncertainty has significant dampening effects on capital investment of small firms by exacerbating their financial constraints, and that this negative effect is amplified by firm-level constraints on ability to hedge risk exposures. The Internet appendix is available at https://doi.org/10.1287/mnsc.2017.2815 . This paper was accepted by Amit Seru, finance.
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ISSN:0025-1909
1526-5501
DOI:10.1287/mnsc.2017.2815