Productivity or Unexpected Demand Shocks: What Determines Firm-Level Investment and Exit Decisions?
International Economic Review, Vol. 60, No. 1, February 2019 DOI: 10.1111/iere.12354
25 Pages Posted: 12 Dec 2022
Date Written: February 16, 2019
Abstract
We investigate the roles played by unexpected demand shocks, besides productivity, on firms' capital investment and exit decisions. We propose a practical approach to recover unexpected firm-level demand shocks using inventory data. The recognition of demand shocks and inventory also improves the productivity estimation. The empirical results indicate that although productivity and demand shocks are both significant factors determining firm behavior, the former is more dominant for investment decision and the latter is more salient for firm exit. These findings confirm that unexpected demand shocks, besides persistent productivity, are important factors when analyzing capital investment and firm exit decisions.
Keywords: Demand Shock, Productivity, Inventory, Production Function Estimation, Investment, Firm Turnover
JEL Classification: D24, L11, D25
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