Macroeconomic Conditions, Nature of Competition, and Investment Cyclicality
51 Pages Posted: 8 Sep 2009
Date Written: September 4, 2009
This paper studies the impacts of the interactions between the changing macroeconomic conditions and the nature of competition on firms' investment timing decisions. With a model featuring business-cycle variations in both the profit level and the expected growth rate and volatility of the profit process, I show that i) the macro-level fluctuations "add" or "subtract" values of the investment option or the invested capital, leading to more cyclical investment than that predicted by the traditional single-regime real option models; ii) relative to monopoly, competition partially consumes the added or subtrated values, making the investment typically more cyclical in the monopolized industry than in the competitive industry, which is contrast to the conventional wisdom (Leahy, 1993) that the two industries adopt identical investment policies. I document evidences that support the model's predictions. In terms of the implied welfare, non-optimal policies in general provide close-to-optimal outcomes, particularly for the competitive firms.
Keywords: macroeconomic condition, nature of competition, regime switching effect, investment threshold
JEL Classification: E22, G13, G31
Suggested Citation: Suggested Citation