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

See all articles by Pradeep Kumar

Pradeep Kumar

University of Exeter Business School - Department of Economics

Hongsong Zhang

University of Hong Kong

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

Suggested Citation

Kumar, Pradeep and Zhang, Hongsong, Productivity or Unexpected Demand Shocks: What Determines Firm-Level Investment and Exit Decisions? (February 16, 2019). International Economic Review, Vol. 60, No. 1, February 2019 DOI: 10.1111/iere.12354, Available at SSRN: https://ssrn.com/abstract=4278217

Pradeep Kumar

University of Exeter Business School - Department of Economics ( email )

Streatham Court
Exeter, EX4 4RJ
United Kingdom

Hongsong Zhang (Contact Author)

University of Hong Kong ( email )

Pokfulam Road
Hong Kong
Hong Kong

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